Corporate Valuation and Dividends: UK Evidence from Panel Unit Root and Cointegration Tests
Gregoriou, Andros, Atlantic Economic Journal
The empirical relationship between dividends and market value in the corporate valuation model developed by Ohlson (I 989) has been at the forefront of accounting research over the last decade. Rees (1997) and Akbar and Stark (2003) discover that dividends have a positive influence on corporate valuation in the UK. Giner and Rees (1999) repeat the Rees (1997) and Akbar and Stark (2003) results for the USA and Spain respectively. The positive impact of dividends on company valuation could be attributed to the fact that they signal managers' private information about future profitability (Rees 1997; Akbar and Stark 2003), and because they are a proxy for investors' mispricing of current earnings or book value (Hand and Landsman 2005). The typical econometric approach for the studies mentioned above is to use a sample of observations taken for many companies over several time periods, with estimation being based on OLS pooled techniques (where all the years are assumed identical). An implicit assumption made in this methodology is that the explanatory variables in the corporate valuation model follow a stationary process.
It is well established that the use of OLS regression to analyse a non stationary series can lead to serious problems for inferential statistics. This is because the residual term generated from the regression is serially correlated through time. The violation of the assumption that residual terms are independent and uncorrelated typically leads to an underestimated residual variance and an underestimated standard error of the regression coefficient on earnings. This results in biased regression coefficients, and unreliable significance tests for parameter estimations since the t statistics generated from the regression do not follow the standard t distribution. It is in this sense that econometricians call models based on non stationary time series "spurious regression" (see among others, Engle and Granger 1987; loannidis et al. 2003).
In this study we establish that the most typically used explanatory variables in the Ohlson (1989) company valuation model which are the book value, earnings and dividends all following non stationary, I(1) integrated processes. This suggests that the statistical inferences based on the association of dividends and company valuation used in the previous literature may be spurious. Therefore, in order to provide valid econometric relationships between dividends and corporate valuation we employ cointegration analysis, which provides appropriate test statistics in the presence of I(1) variables. More specifically the paper makes the follow contributions to the existing literature.
First, we use panel unit root tests to examine the stationarity properties of the data. The use of panel based tests is necessary because the power of time series unit root tests will be low given the short time span available in annual company valuation data. Second, panel cointegration tests are conducted because the multivariate cointegration time series analysis of Johansen (1988) suffers from power loss due to finite samples. Finally, cointegrating vectors are estimated using the fully modified (FM) OLS estimation technique for heterogeneous cointegrated panels developed by Pedroni (2000). This methodology allows consistent and efficient estimation of cointegrating vectors. In addition, it deals with the possible endogeneity problem of the explanatory variables and it respects the time-series properties of the data in that integration and cointegration properties are explicitly taken into account.
The remainder of the paper is organized in the following way. In the following section, we present the corporate valuation model and the econometric techniques used in the study. We then proceed with a description of the data. The results are discussed in the empirical results section. The final section concludes our findings.
The Model and Econometric Techniques
Following Rees (1997) and Akbar and Stark (2003) we investigate the relationship between dividends and corporate valuation in the Ohlson (1989) company valuation model, with the use of the following linear econometric specification. …