‘Is Residual Income Model (RIM) Really Superior to Dividend Discount Model (DDM)?’ – A Misconception

IOSR Journal of Business and Management (IOSR-JBM), Volume 5, Issue 6 (Nov. -Dec.), Page 36-44 , ISSN: 2278-487X. DOI: 10.9790/487X-0563644, 2012

13 Pages Posted: 22 Nov 2012 Last revised: 5 May 2013

See all articles by M. A. Tareq

M. A. Tareq

Malaysia-Japan International Institute of Technology (MJIIT), Universiti Technologi Malaysia (UTM)

Date Written: November 21, 2012

Abstract

The development of the residual income model (RIM) has potential implications for the empirical researchers as the model specifies relationship between earnings and book values as proxies for equity values and accounting variables. Although researchers have supported RIM as an alternative to the dividend discount model (DDM), some empirical studies on RIM have triggered arguments on the superiority of the RIM over DDM. In theory, both models give the same value estimates; empirically, these value estimates changes with the changes in the assumption sets. In this paper, we show that both models provide the same values estimates when the terminal value can be forecasted. Although, under the perpetual growth rate model, the researchers have shown that empirically RIM outperforms DDM. We have shown that this superiority of RIM is misleading, as the transversality condition, a necessary assumption for deriving the RIM, is void under the perpetual growth rate scenario.

Keywords: Book Value, Clean Surplus Relation (CSR), Dividend Discount Model (DDM), Residual Income Model (RIM), Valuation

JEL Classification: M41, G12

Suggested Citation

Tareq, Mohammad Ali, ‘Is Residual Income Model (RIM) Really Superior to Dividend Discount Model (DDM)?’ – A Misconception (November 21, 2012). IOSR Journal of Business and Management (IOSR-JBM), Volume 5, Issue 6 (Nov. -Dec.), Page 36-44 , ISSN: 2278-487X. DOI: 10.9790/487X-0563644, 2012 , Available at SSRN: https://ssrn.com/abstract=2179059 or http://dx.doi.org/10.2139/ssrn.2179059

Mohammad Ali Tareq (Contact Author)

Malaysia-Japan International Institute of Technology (MJIIT), Universiti Technologi Malaysia (UTM) ( email )

Kuala Lumpur, 54100
Malaysia

HOME PAGE: http://mjiit.utm.my/contact-staff-tareq/

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