A Study On The Applicability Of Residual Income Model

The disclosure of accounting information should be useful for the existing or potential investors, creditors and other types of investors to make investment decisions. In another words, the disclosure of accounting information should be based on the "decision-make usefulness". Under this background, it is indeed necessary to research how accounting information works in capital market. At this matter, Ohlson proposed a new research perspective with the Residual Income Model.Firstly, this article introduces the interaction mechanism between the accounting information and the stock price under the information perspective, valuation perspective and measurement perspective respectively. Compared with the rationality of the models and the feasibility of the empirical research, the author chooses the Residual Income Model under the valuation perspective as the basic research method finally. Then the author introduces the theory of the Residual Income Model and the relative literature.The Residual Income Model is based on three assumptions, which are the Dividend Discount Model, the Clean Surplus Relation and the Linear Information Dynamic Process. Through these three hypotheses, the linear relationship between stock price and net assets per share and residual earnings per share would be established. With the Chinese stock market data between 2003 to 2013, this paper empirically tests the applicability of Residual Income Model applied into Chinese capital market. The empirical results reveals:(1) The current residual income per share is positive correlated with the previous period residual income per share significantly, and the correlation coefficients are between 0 and 1. The empirical results show that the residual income per share meets the requirement of the Linear Information Dynamic Process.(2) Although the explanatory power of the residual income model as a whole is increasing year by year, the model also has certain volatility because of the influence of the interim development of the capital market. The regression coefficients of net assets per share and residual income per share are positive significantly, and the residual income per share has a greater price multiplier. The net assets per share and the residual income per share provides each other mutually with significant incremental explanatory power.(3) After the year of 2006, the explanatory power of the Residual Income Model has increased significantly. The reason might be the promulgation of new accounting standards system, which include the 《Accounting Standard for Business Enterprises-Basic Standard》 issued by the Ministry of Finance of PRC on 15 February 2006 and 38 new accounting regulations, these regulations improved the applicability of the model because the fair value is regulated into accounting measurement attributes.(4) The institutional investors shareholding ratio, company size and the proportion of shares in circulation are related to the share price significantly. Residual income per share, net assets per share and institutional investors shareholding ratio are prominent positive relevant in share price, while company size and the proportion of shares in circulation have a significant negative correlation with stock price.(5) The industrial characteristics, growth and negative or positive number of residual income have an influence on the application of the model. Firstly, compared with the information and technology industry, the accounting information has a stronger influence on the stock price of the manufacturing industry, and the pricing multiplier of the residual income is larger. Secondly, the adaptability of the model and the price multiplier of residual income per share are positively correlated between the high-growth company, low-growth company and the minus-growth company. However, net assets per share is just the opposite condition. Thirdly, when the residual income is negative, the application of the Residual Income Model is poor. There is almost no correlation between residual income and stock price under this situation.