Testing the Ohlson Model : V or Not V, that is the Question

This paper tests the sharply differing predictions that emerge in Ohlson?s (1995) model from two assumptions about other information v that is reflected in a firm?s equity market value but not in its current financial statements. We find that neither assumption cleanly fits the data. If v is assumed to be zero, the regression multiple relating dividends to equity market value is reliably positive when it is predicted to be negative. Alternatively, if v impacts future abnormal earnings via Ohlson?s modified AR(1) information dynamic, then the signs on the multiples on current period net income and net capital stock outflows are positive and negative, respectively, when they should be the opposite. Our explanation for these anomalies is that dividends play a profitability-signaling role that is ruled out by Ohlson?s model. Consistent with this, we find that the multiple relating dividends to equity market value is more positive for loss firms, and that Ohlson?s information dynamics are violated in that larger dividends are associated with larger future abnormal earnings, especially for loss firms. Surprisingly, holding constant this profitability-signaling role of dividends, equity market values appear reasonably consistent with v being zero. This implies that the role of information outside key aggregate accounting numbers in current financial statements in setting prices may be more limited than previously thought. Equivalently, current accounting rules may capture the economic information reflected in stock prices in a more timely manner than is typically thought