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owner's equity value measured at its historical cost at the end of the previous period t -1,
and the overall numerator denotes the “residual income” as defined by Ohlson (1995).
The left hand side variable,
*
, thus denotes the computed fundamental value. We
V
~
define
is the effective corporate tax rate for period
t + k. B t is the owner's equity value measured at its historical cost at the end of the
previous period t -1,
on a before tax basis,
τ
*
N
I
c
,
t
+
k
t
+
k
~
r ,
is the future net income stream,
is the discount rate
N
I
t
t
+
k
which is the cost of equity, and
Φ t
is the publicly available information set at the end
1
of time t -1,
~
~
*
E
(
N
I
×
(
τ
)
r
B
)
Φ
)
=
*
t
t
+
k
c
,
t
+
k
e
,
t
t
+
k
1
t
1
V
=
B
+
(9)
t
t
(
+
r
)
k
k
1
e
,
t
r , , is the rate of return before
personal tax, which can vary over time, and we estimate the cost of equity based on
publicly available information using the Fama and French model. 10 In order to
estimate
In the following, we assume that the cost of equity,
t
r , we use the unconditional version of the three-factor model (Fama and
French, 1993).
Every year we compute the fundamental value of firms on June 30 after all
financial statements from the March 31 fiscal year end become publicly available and
are approved at shareholder meetings before the end of June, which is a time limit
according to Article 24 of Financial Instruments and Exchange Act of Japan. Note we
use only the sample of firms whose fiscal year ends March 31, which amounts to
more than 90 percent of all the listed firms on the Tokyo Stock Exchange.
Note the valuation equation (11) includes the summation of an infinite time
horizon. However, in the Monte Carlo simulation framework, we compute the
intrinsic value of firms by assuming that residual income becomes zero after the year
t =21. Consequently, after generating the sample paths of residual income from taxable
income, we sum up the present value of the residual income for the years t =1,…,20.
t
4
Basic Data and the Simulation Method
4.1
Data and Basic Observations
Our financial data is based on consolidated financial statements of all Japanese firms
listed on the First and Second Section of the Tokyo Stock Exchange starting from
calendar year 2000 (fiscal year 1999) through 2009 (2008), excluding financial firms
and other firms in industries without data on fixed assets. 11 We exclude sample firms
10 See Brennan (1970) for CAPM specifications where personal tax parameters are included.
However, in this paper we do not consider that Miller (1977) equilibrium holds equivocally
in an economy and we discount after-tax residual income by the rate of return on stock
before the corporate tax basis.
11 Naturally some firms in a particular industry do not have material fixed assets and do not
disclose. We also exclude these firms from our sample.
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