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Dividend policy irrelevancy and the construct of earnings

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<mark>Journal publication date</mark>06/2013
<mark>Journal</mark>Journal of Business Finance and Accounting
Issue number5-6
Volume40
Number of pages22
Pages (from-to)673-694
Publication statusPublished
Early online date14/05/13
Original languageEnglish

Abstract

This paper analyzes the characteristics of earnings in valuation settings where the dividend policy is irrelevant to equity value. The paper first demonstrates an equivalent characterization of dividend policy irrelevancy (DPI) in a general linear dynamic. It then proceeds to show how DPI leads to ideal and practical constructs of earnings and examines their analytical properties. We further demonstrate that earnings properties can be used to deduce the core approach in practical equity valuation; namely, measures of growth in expected earnings explain the price to forward earnings ratio. However, unlike dividends, free cash flow cannot generally be claimed to be irrelevant.