Valuation and Growth Rates Manipulation

Abstract

Valuation requires the prediction of future growth rate of persistent earnings, which depend on past and present internal, unobservable, investment decisions. In this study, we investigate the “management” of the series of growth rates in a multi-period principal-agent model with a moral hazard problem between owners (the principal) and the manager (the agent). We find that the manager’s choice of efforts might yield a series of increasing expected growth rates, contrary to owners’ preferences. Consequently, the extrapolation of expected future earnings of an owner-controlled firm should differ from that of a management-controlled firm.