Residual Income and value-creation: the missing link

This paper extends the residual income literature to provide a framework for the use of residual income in performance measurement, applicable in value-based management. It shows that, under a simple initializing assumption, an accounting-free measure of ‘excess value created‘ over a multi-period interval can be written entirely in terms of (i) within-interval realized residual incomes and (ii) end-of-interval expected future residual incomes, both appropriately adjusted for the time value of money. It also shows that, when the simple initializing assumption is relaxed, excess value created can be expressed in terms of ‘excess residual incomes‘, measured by comparison with expectations as at the beginning of the multi-period interval.