Lundholm and O’Keefe (2001) state “while all authors acknowledge that the models are equivalent in theory, they proceed to compare them anyway based loosely on the idea that in a practical implementation or a large-sample study, the models can vary.” They claim that there is nothing to be learned from the empirical comparison of valuation models and thus dismiss the research of Penman (2001) and others claiming the superiority of accrual accounting based residual income models (RIVM)

(a) Give a full explanation of the Lundholm and O’Keefe criticism on Penman’sresearch with particular reference to how prior research has applied inconsistent assumptions.

(b) Lundholm and O’Keefe use the term “clean surplus”. What does the term mean? Give two examples of why “clean surplus” may not be achieved.

.(c) What is the justification for Penman’s assertion that Lundholm and O’Keefe’sclaim is misguided? (refer to Penman’s response paper). Whom do you agreewith and why?  

(d) One of your friends who graduated last year argues that the abnormalearnings model (AEG) has an advantage over the RIVM since AEG does notrely on clean surplus relation. Comment on this viewpoint.