Centre for Discrete and Applicable Mathematics

CDAM Research Report, LSE-CDAM-2006-23

January 2007

Dividend Policy Irrelevancy and the Construct of Earnings

James A. Ohlson, Adam J. Ostaszewski, and Zhan Gao

In a neo-classical setting of equity-valuation, this paper develops a principle of dividend policy irrelevancy (DPI) to identify and exploit characteristics of earnings. The latter refers to the idea that a value-relevant variable can not reasonably be labeled "earnings" unless it satisfies certain analytical properties with intuitive appeal. The paper proceeds in two parts. The first part, which culminates in Proposition I, provides necessary and sufficient conditions for DPI. The second part concerns how DPI predicates constructs of earnings and their analytical properties. A key result, Proposition II, shows that one can use the analytical properties of earnings to deduce the core approach in practical equity-valuation, namely, measures of growth in expected earnings explain the price to forward-earnings ratio.

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		Phone: +44(0)-20-7955 7494. Fax: +44(0)-20-7955 6877. Email: info@maths.lse.ac.uk