Overstating productivity at the firm level primarily affects which models?

Overstating productivity at the firm level has implications for both the Gordon model and the H-model, which are both used in dividend discount modeling for valuing stocks.

The Gordon model, also known as the Gordon Growth Model, is based on the premise of constant growth in dividends. If productivity is overstated, it can lead to a misguided expectation of future dividend growth, resulting in an inflated valuation of the firm. The model's reliance on accurate growth estimates means that overstated productivity would skew the expected future dividends higher, which would inaccurately assess the stock's value.

Similarly, the H-model, which is a variation of the Gordon model, accounts for a two-stage growth process—initial high growth that gradually declines to a stable growth rate. Overstating productivity here would also misrepresent the initial growth phase, leading to potential overvaluation. Investors might assume higher future cash flows and dividends based on faulty productivity estimates, which can distort the ultimate share price derived from the model.

Thus, overstated productivity affects the assumptions of both models by providing an overly optimistic view of growth potential, leading to inaccuracies in valuation assessments. This clarity on the impact of productivity assumptions ensures understanding of how valuations may be skewed in financial analysis.