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Carlo Alberto Magni - One of the best experts on this subject based on the ideXlab platform.
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Axiomatization of Residual Income and generation of financial securities
Quantitative Finance, 2012Co-Authors: Roberto Ghiselli Ricci, Carlo Alberto MagniAbstract:This paper presents an axiomatization of Residual Income, also known as excess profit, and illustrates how it can univocally give rise to fixed-Income or variable-Income assets. In the first part it is shown that, depending on the relations between excess profit and the investor's excess wealth, a well-specified theory of Residual Income is generated: one is the standard theory, whichvhistorically traces back to Hamilton (1777) and Marshall (1890) and is a deep-rooted notion in\ud economic theory, finance, and accounting. Another one is the systemic value added or lost-capital paradigm: first introduced in Magni (2000, 2003), the theory is enfolded in Keynes's (1936) notion of user cost and is naturally generated by an arbitrage-theory perspective. In the second part, the paper reverts the usual analysis: instead of computing Residual Incomes from a pattern of cash flows, Residual Incomes are fixed first to derive vectors of cash flows. It is shown that variable- or fixed-Income assets may be constructed on the basis of either theory starting from pre-determined growth rates for Residual Income. In particular, zero-coupon bonds and coupon bonds traded in a capital market are shown to be deducted as equilibrium vectors of Residual-Income-based assets
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Residual Income and Value Creation: An Investigation into the Lost-Capital Paradigm
European Journal of Operational Research, 2010Co-Authors: Carlo Alberto MagniAbstract:This paper presents a new way of measuring Residual Income, originally introduced by Magni (2000a,b,c, 2001a,b, 2003). Contrary to the standard Residual Income, the capital charge is equal to the capital lost by investors multiplied by the cost of capital. The lost capital may be viewed as (a) the foregone capital, (b) the capital implicitly infused into the business, (c) the outstanding capital of a shadow project, (d) the claimholders' credit. Relations of the lost capital with book values and market values are studied, as well as relations of the lost capital Residual Income with the classical standard paradigm; many appealing properties are derived, among which an aggregation property. Different concepts and results, provided by different authors in such different fields as economic theory, management accounting and corporate finance, are considered: O'Hanlon and Peasnell's (2002) unrecovered capital and Excess Value Created; Ohlson's (2005) Abnormal Earnings Growth; O'Byrne's (1997) EVA improvement; Miller and Modigliani's (1961) investment opportunities approach to valuation; Young and O'Byrne's (2001) Adjusted EVA; Keynes's (1936) user cost; Drukarczyk and Schueler's (2000) Net Economic Income; Fernandez's (2002) Created Shareholder Value; Anthony's (1975) profit. They are all conveniently reinterpreted within the theoretical domain of the lost-capital paradigm and conjoined in a unified view. The results found make this new theoretical approach a good candidate for firm valuation, capital budgeting decision-making, managerial incentives and control.
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splitting up value a critical review of Residual Income theories
European Journal of Operational Research, 2009Co-Authors: Carlo Alberto MagniAbstract:This paper deals with the notion of Residual Income, which may be defined as the surplus profit that residues after a capital charge (opportunity cost) has been covered. While the origins of the notion trace back to the 19th century, in-depth theoretical investigations and widespread real-life applications are relatively recent and concern an interdisciplinary field connecting management accounting, corporate finance and financial mathematics (Peasnell, 1981, 1982; Peccati, 1987, 1989, 1991; Stewart, 1991; Ohlson, 1995; Arnold and Davies, 2000; Young and O'Byrne, 2001; Martin, Petty and Rich, 2003). This paper presents both a historical outline of its birth and development and an overview of the main recent contributions regarding capital budgeting decisions, production and sales decisions, implementation of optimal portfolios, forecasts of asset prices and calculation of intrinsic values. A most recent theory, the systemic-value-added approach (also named lost-capital paradigm), provides a different definition of Residual Income, consistent with arbitrage theory. Enfolded in Keynes's (1936) notion of user cost and forerun by Pressacco and Stucchi (1997), the theory has been formally introduced in Magni (2000a,b,c; 2001a,b; 2003), where its properties are thoroughly investigated as well as its relations with the standard theory; two different lost-capital metrics have been considered, for value-based management purposes, by Drukarczyk and Schueler (2000) and Young and O'Byrne (2001). This work illustrates the main properties of the two theories and their relations, and provides a minimal guide to construction of performance metrics in the two approaches.
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Axiomatization of Residual Income and generation of financial securities
SSRN Electronic Journal, 2009Co-Authors: Roberto Ghiselli Ricci, Carlo Alberto MagniAbstract:This paper presents an axiomatization of Residual Income, aka excess profit, and illustrates how it may univocally engenders fixed-Income or variable-Income assets. In the first part it is shown that, depending on the relations between excess profit and the investor's excess wealth, a well-specified theory of Residual Income is generated: one is the standard theory, which historically traces back to Hamilton (1777) and Marshall (1890) and is a deep-rooted notion in economic theory, finance, and accounting. Another one is the systemic value added or lost-capital paradigm: introduced in Magni (2000, 2003), the theory is enfolded in Keynes's (1936) notion of user cost and is naturally generated by an arbitrage-theory perspective. In the second part, the paper reverts the usual analysis: instead of computing Residual Incomes profits from a pattern of cash flows, Residual Incomes are fixed first to derive vectors of cash flows. It is shown that variable- or fixed-Income assets may be constructed on the basis of either theory starting from pre-determined growth rates for excess profit. In particular, zero-coupon bonds and coupon bonds traded in a capital market are shown to be deducted as equilibrium vectors of Residual-Income-based assets.
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Systemic Value Added: An Alternative to EVA as a Residual Income Model (Valore Aggiunto Sistemico: un'alternativa all'EVA quale indice di sovraprofitto periodale)
2008Co-Authors: Carlo Alberto MagniAbstract:This work presents a notion of Residual Income called Systemic Value Added (SVA). It is antithetic to Stewart's (1991) EVA, though it is consistent with it in overall terms: a project's Net Final Value (NFV) can be computed as the sum of capitalized EVAs or as the sum of uncapitalized SVAs. As a result, SVA and EVA decompose the NFV in different ways. Two numerical examples show the application of the model proposed. The two notions are the result of a different cognitive approach. The existence of possible formal translations of the Residual Income concept induces to regard Residual Income as a mere conventional notion.
James S. Wallace - One of the best experts on this subject based on the ideXlab platform.
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Adopting Residual Income-Based Performance Measures: Do You Get What You Pay for?
1998Co-Authors: James S. WallaceAbstract:It has been argued that compensation plans based on a Residual Income performance measure help mitigate dysfunctional behavior associated with plans based on traditional accounting measures. This paper develops and empirically tests hypothesized managerial actions associated with Residual Income-based performance measure incentives. A sample of forty firms that began using a Residual Income performance measure in their compensation plans is compared to a matched-pairs control sample of firms that continue to use traditional accounting earnings-based incentives. The results generally support the hypothesized managerial actions. Overall, I find that "you get what you measure and reward."
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Adopting Residual Income-Based Compensation Plans: Evidence of Effects on Management Actions
1997Co-Authors: James S. WallaceAbstract:It has been asserted that compensation plans based on a Residual Income performance measure help mitigate dysfunctional behavior associated with plans based on accounting earnings. This assertion is empirically tested by selecting a sample of firms that have begun using a Residual Income performance measure in their compensation plans and comparing their performance to a control sample of firms that continue to use traditional accounting earnings-based incentives. Relative to the control firms, these firms 1) decreased their new investment and increased their dispositions of assets, 2) increased their shareholder payouts, and 3) more efficiently used their assets. Further, evidence suggests that market participants respond favorably to adoption of Residual Income-based compensation plans. For the sample of firms studied, I interpret the results as being consistent with a Residual Income-based performance measure providing incentives for managers to act more like owners, thus mitigating the inherent conflict between managers and shareholders.
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Adopting Residual Income-based compensation plans: Do you get what you pay for?
Journal of Accounting and Economics, 1997Co-Authors: James S. WallaceAbstract:Abstract Managers, consultants, and the financial press assert that compensation plans based on Residual Income change managers' behavior. This assertion is empirically tested by selecting a sample of firms that began using a Residual Income performance measure in their compensation plans and comparing their performance to a control sample of firms that continue to use traditional accounting earnings-based incentives. The results generally support the adage `you get what you measure and reward'. The results also support many hypothesized managerial actions associated with Residual Income-based performance measure incentives.
Regina M. Anctil - One of the best experts on this subject based on the ideXlab platform.
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The Asymptotic Optimality of Residual Income Maximization
Review of Accounting Studies, 1998Co-Authors: Regina M. Anctil, James S. Jordan, Arijit MukherjiAbstract:Residual Income subtracts from operating Income an interest charge for invested capital. Residual Income can be calculated each period from current accounting information, unlike discounted cash flow (DCF), which requires the knowledge of future cash flows. This paper provides a normative justification for Residual-Income maximization by showing that if investment decisions are made myopically each period to maximize Residual Income, the resulting path asymptotically maximizes discounted cash flow. Thus, under the assumptions of the model, Residual-Income maximization is a heuristic that leads to the long-run DCF-optimum.
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Capital budgeting using Residual Income maximization
Review of Accounting Studies, 1996Co-Authors: Regina M. AnctilAbstract:This analysis provides theoretical support for the use of Residual Income. Economic theory states that capital investment should maximize the present value of incremental cash flow. When a firm is decentralized, coordinating the necessary information to determine optimal investment in the short run may be impossible. But, the Residual Income maximizing choice can be coordinated using a simple transfer-pricing system. Under appropriate capitalization and depreciation policies, the Residual-Income maximization policy leads the firm to make suboptimal short-run investment decisions, yet these decisions still lead the firm to its long-run, present-value-maximizing capacity level.
Vasilios Kalogirou - One of the best experts on this subject based on the ideXlab platform.
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Macroeconomic Factors and Company Value in the Context of the Ohlson Residual Income Valuation Model: Empirical Findings from Greece
International Journal of Sustainable Economies Management, 2013Co-Authors: Konstantinos Vergos, Apostolos G. Christopoulos, Vasilios KalogirouAbstract:Over the past decades the Ohlson Residual Income Model for equity valuation has drawn much attention concerning its advantages when compared to traditional models (DDM, FCFM). This paper attempts to empirically investigate the validity of the Ohlson Residual Income model using data from the Greek economy over the period 1969-2001. By using multiple regression analysis and by incorporating macroeconomic factors as explanatory variables, we investigate the link of accounting and macroeconomic factors in the market valuation of major Greek companies listed in the Athens Stock exchange. We find that the performance of the Ohlson Residual Income Model is quite satisfactory and the use of factors such as commodity prices, discount rates, and market level in some cases add to the explanatory power of the examined model. Our findings are important for both economists and fund managers, because they show that a relation between accounting and macroeconomic data is valid in the Greek market and economy, alongside more developed markets.
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Macroeconomic Factors as Determinants of Company Value in the Context of the Ohlson Residual Income Valuation Model; Greek Findings
SSRN Electronic Journal, 2011Co-Authors: Konstantinos Vergos, Apostolos G. Christopoulos, Vasilios KalogirouAbstract:Over the past two decades the Ohlson Residual Income Model for equity valuation has drawn much attention concerning its advantages when compared to traditional models (DDM, FCFM). This paper attempts to empirically investigate the validity of the Ohlson Residual Income model using data from the Greek economy over the period 1969-2001. By using multiple regression analysis and by incorporating macroeconomic factors as explanatory variables, we investigate the link of accounting and macroeconomic factors in the market valuation of major Greek companies listed in the Athens Stock exchange. We find that the performance of the Ohlson Residual Income Model is quite satisfactory and the use of factors such as commodity prices, discount rates, and market level in some cases add to the explanatory power of the examined model. Our findings are important for both economists and fund managers, because they show that a relation between accounting and macroeconomic data is valid in the Greek market and economy, alongside more developed markets.
Komlan Sedzro - One of the best experts on this subject based on the ideXlab platform.
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Earnings multifactor process, Residual Income valuation, and long-run risk
2019Co-Authors: Claude Bergeron, Jean-pierre Gueyie, Komlan SedzroAbstract:In this paper, we extend the Residual Income valuation model by incorporating the long-run sensitivity of earnings to various economic factors. Our valuation procedure integrates the multidimensionality of uncertainty, as well as the long-run concept of risk (recently proposed in finance and accounting). Our extension model begins with an earnings multifactor process, uses an intertemporal equilibrium version of the Residual Income valuation method, and sums over many periods. In this manner, we demonstrate that the abnormal earnings growth rate of a firm is linearly and positively related to N sensitivity coefficients, given by the long-run sensitivity between abnormal earnings and economic factors. We then reveal that the corresponding equity value of the firm is a function of the current book value, abnormal earnings, and N long-run risk parameters. In the context of the Residual Income valuation approach, these findings suggest that earnings sensitivity to several factors represents an additional technique to estimate risk (in the long run).
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Consumption, Residual Income Valuation, and Long-run Risk
2018Co-Authors: Claude Bergeron, Jean-pierre Gueyie, Komlan SedzroAbstract:This paper develops a theoretical extension of the Residual Income valuation model that integrates the concept of long-run risk. The model starts with an intertemporal framework, assumes the clean surplus accounting relation, and expresses firm market value as the book value of equity plus the present value of expected future Residual Income. The main finding of the extension model indicates that a firm’s goodwill is negatively related to its accounting risk, measured by the long-run covariance of the firm’s abnormal earnings growth and aggregate consumption growth. In the context of the Residual Income valuation method, this finding suggests that the earnings-consumption covariance (in the long run) represents an appropriate accounting risk measurement of a firm’s intrinsic value.