Positive (Zero) NPV projects and the behavior of residual earnings / Discussion

This study analyzes the time-series behavior of residual earnings as it relates to the existence of positive net present value (NPV) opportunities (or "rents"). The issue is of interest because many recent papers, such as Lo and Lys, 1999, and Holthausen and Watts, 2001, have commented on it in the context of the Ohlson (1995) model. The unbiased accounting property of the Ohlson model depends on the assumption of mean zero autoregressive abnormal earnings dynamics. The Ohlson model is a reduced form model. It does not explicitly model operating cash flows and it does not articulate the accounting rules that underpin the measurement of (abnormal) earnings conditional on cash flow. The analysis shows that the Ohlson (1995) model allows for positive NPV opportunities, contrary to the frequently made claims.