Rights statement: This is the peer reviewed version of the following article: Christodoulou, D., Clubb, C., and Mcleay, S. (2016) A Structural Accounting Framework for Estimating the Expected Rate of Return on Equity. Abacus, 52: 176–210. doi: 10.1111/abac.12073 which has been published in final form at http://onlinelibrary.wiley.com/doi/10.1111/abac.12073/abstract This article may be used for non-commercial purposes in accordance With Wiley Terms and Conditions for self-archiving.
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Final published version
Research output: Contribution to Journal/Magazine › Journal article › peer-review
Research output: Contribution to Journal/Magazine › Journal article › peer-review
}
TY - JOUR
T1 - A structural accounting framework for estimating the expected rate of return on equity
AU - Christodoulou, Demetris
AU - Clubb, Colin
AU - McLeay, Stuart James
N1 - This is the peer reviewed version of the following article: Christodoulou, D., Clubb, C., and Mcleay, S. (2016) A Structural Accounting Framework for Estimating the Expected Rate of Return on Equity. Abacus, 52: 176–210. doi: 10.1111/abac.12073 which has been published in final form at http://onlinelibrary.wiley.com/doi/10.1111/abac.12073/abstract This article may be used for non-commercial purposes in accordance With Wiley Terms and Conditions for self-archiving.
PY - 2016/3
Y1 - 2016/3
N2 - This paper shows how the expected rate of return (ERR) on equity may be estimated using only published accounting results, based on the information dynamics of reported earnings. As accounting-based valuation models conditional upon financial statement articulation lead to a rank deficient system of estimating equations, the paper introduces a nonlinear constraint on the articulation that allows the information system simultaneously to produce an estimate for the ERR by iteration, together with predictions for the key clean surplus forecasts of net earnings, net dividend, and the book value of equity. Further decomposition produces estimates of expected capital gain, expected earnings, and the expected change in equity book value, and by rearrangement, the expected change in unrecorded goodwill. The clean surplus relation is maintained in the forecast variables. Exploratory data methods are used to examine the nonlinear relationship between components of the accounting-based ERR and realized stock returns. Findings show that realized returns are higher (lower) than estimated ERR in expansionary (recessionary) periods, with evidence of a stronger returns impact in recessionary periods. For the large majority of firms, realized returns revert to the estimated ERR, and the time-varying accounting components are strongly related to future realized stock returns, consistent with time variation in the ERR around a long-run average. Predicted earnings and dividends provide useful additional information on short-run variations in the ERR.
AB - This paper shows how the expected rate of return (ERR) on equity may be estimated using only published accounting results, based on the information dynamics of reported earnings. As accounting-based valuation models conditional upon financial statement articulation lead to a rank deficient system of estimating equations, the paper introduces a nonlinear constraint on the articulation that allows the information system simultaneously to produce an estimate for the ERR by iteration, together with predictions for the key clean surplus forecasts of net earnings, net dividend, and the book value of equity. Further decomposition produces estimates of expected capital gain, expected earnings, and the expected change in equity book value, and by rearrangement, the expected change in unrecorded goodwill. The clean surplus relation is maintained in the forecast variables. Exploratory data methods are used to examine the nonlinear relationship between components of the accounting-based ERR and realized stock returns. Findings show that realized returns are higher (lower) than estimated ERR in expansionary (recessionary) periods, with evidence of a stronger returns impact in recessionary periods. For the large majority of firms, realized returns revert to the estimated ERR, and the time-varying accounting components are strongly related to future realized stock returns, consistent with time variation in the ERR around a long-run average. Predicted earnings and dividends provide useful additional information on short-run variations in the ERR.
KW - Clean surplus
KW - Rank deficiency
KW - Expected rate of return
KW - Equity valuation
U2 - 10.1111/abac.12073
DO - 10.1111/abac.12073
M3 - Journal article
VL - 52
SP - 176
EP - 210
JO - Abacus
JF - Abacus
SN - 0001-3072
IS - 1
ER -