Residual Income versus Earnings: Which Measure is more Associated with Shareholder Wealth Creation?
Lim, Agnes Geok-Ching (2004) Residual Income versus Earnings: Which Measure is more Associated with Shareholder Wealth Creation? [Dissertation (University of Nottingham only)] (Unpublished)
This study aims to test on an empirical basis which measure, a value-based measure such as residual income (“RI”) or the traditional measure such as earnings, is more closely associated with shareholder wealth creation. Motivation for the study emanates from the increasing emphasis on shareholder wealth creation in Malaysia and interest in the value-based measures for it. It has also been encouraged by Stern Stewart’s recent claim through the Malaysian press that Economic Value Added (“EVA”), an RI concept, is the measure most directly linked to shareholder wealth creation over time. A good performance measure is seen as one which is a good barometer of shareholder wealth creation. A measure which highly correlates with changes in shareholder wealth would appeal to shareholders as it fits into their objective of maximising the value of their investment. Hence, it would be useful to know which of the two performance measures has higher correlation with shareholder wealth creation.The study involves relative and incremental information content tests, carried out by performing annual regression analysis on data covering a 5-year period from year 1999 to 2003. Sample firms comprise listed Malaysian companies which form the Kuala Lumpur Composite Index. Two forms of measures are used for shareholder wealth creation, namely,actual and abnormal share returns. Actual share return takes into account changes in the equity market value and dividends of firms. Abnormal share return refers to actual share return that is in excess of expected return, given the risk of the investment.Our results reveal earnings to be the measure more closely associated with shareholder wealth
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