Relationship between accounting information and share prices

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  1. INTRODUCTION

Value relevance is one of the basic attribute of quality of the financial statements. The concept of the value relevance of accounting information is defined as ‘‘the ability of accounting numbers to summarize the information underlying the stock prices, thus the value relevance is indicated by a statistical association between financial information and prices or returns’’(Jianwei and Chunjiao, 2007). Listed companies use financial statements as one of the major medium of communication with their stakeholders. Therefore, stock market regulators and accounting standards setters trying to improve the quality of financial statements in order to increase the transparency level in financial reporting (Vishnani and Shah, 2008).

Investors are not in a position to directly access the performance of the company in which they are intended to invest. They usually depend on the financial statements prepared by the management of the company. A key role of financial statements is to summarize business transactions and other events. Financial Statements will consist of different types of information such as Financial Information or relevance accounting information can be described as an essential pre requisite for stock market growth. (Oyerinde, 2009) Under this construct, the value relevance of financial statement information is measured by its ability to capture or summarize information, regardless of source, that affects equity value (Francis and Schipper, 1999). Financial information not only is used to understand the current and past performance and future prediction of company, but also it is used as a tool for planning and controlling the activities of the company. (Khajavi et al., 2010).

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Investors (owners) are considered to be the most important user of accounting data and it is therefore crucial to examine the value relevance of accounting data. Stock market is a place which facilitates corporations to raise equity capital, facilitates continuous economic growth and maintain liquidity for the holder of the stocks who invest in these stocks for the purpose of capital gain. On the other hand the main objective of accounting data is to provide information about the company’s economy to different users inside and outside the company (Smith, 2006). The more investors use accounting information, it is expected that rational decisions are made. But the use of accounting information depends on several factors, some of which are related to users of the information and some others related to the quality and quantity of the information.

Financial information is essential in making sound investment decisions and it will reduce the informational asymmetry problem between the firm’s managers and the investors (Hossain, et al. 2004). Investors also use non-financial information in order to make investment decisions, still conventional investors give more weight to financial information. A main purpose of accounting is to provide investors with relevant information for their investment decisions.

  1. Objective of study
  • To determine the significance of relationship between accounting information and share prices.
  • To determine which variable of study has more explanatory power than the other.
  • To determine the impact of time factor on the relationship between accounting information and share prices in Pakistan.
  1. Significance of study

Accounting information has significance for internal (primary) users as well as for external (secondary) users. Primary users of accounting information include; Management, employees and owners. Secondary users are creditors, tax authorities, customers, investors and regulatory authorities.

Accounting information mostly help the investors in predicting future trends and confirming their past predictions regarding profitability of the company. Hence, this study will help Pakistani investors in decision making as to whether purchase the stocks of company based on their accounting information.

  1. LITERATURE REVIEW

Glezakos et al., (2012) investigated the impact of accounting information on share prices. Sample of 38 listed companies of Athens Stock Exchange was taken for the period 1996 – 2008. Earnings per share (Eit) and Book value per share (BVit) are used as proxy variables for accounting information and are taken as independent variables, whereas, Stock price (Pit) is used as dependent variable in their study. They applied regression on logarithmic values of all variables of the study for each year. They find that jointly the two parameters are value relevant i.e. the explanatory power of the two parameters increases with time. However, earnings per share has less impact on stock prices as compared to book value per share.

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Vijitha and Nimalathasan (2014) investigated the value relevance of accounting information and share prices. Sample of 20 manufacturing companies listed in Colombo Stock Exchange (CSE) are considered for this study for the period of 5 years i.e. from 2008 – 2012. Proxy variables used in this study to measure the accounting information include Earning per Share (EPS), Net Assets Value Per Share (NAVPS), Return On Equity (ROE) and Price Earnings Ratio (P/R) whereas Share Price (SP) is taken as dependent variable. By applying regression analysis technique they find that overall accounting information is significantly related to share prices at 1% significance level but individually EPS and NAVPS have significant whereas, ROE and P/E ratio have insignificant impact on share price.

Keener (2011) examined the relative value relevance of earnings and book value across industries. Data for many industries consisting of 98,284 companies is collected for the time period of 20 years i.e. from 1982 – 2001. Independent variables used in this study are Earnings per share (EPS) and Book value per share (BV) and Price per share (P) is used as dependent variable. Through pooled regression analysis he found that jointly EPS and BV are significant while individually book value is more relevant than earnings per share.

Elisa et al., (2013) studied the impact of accounting information on stock prices. Sample of 46 firms listed at OMX large Cap has been taken for this study. In this study, Book value per share (BVPS) and Earnings per share (EPS) are used as proxy variables for accounting information. By applying OLX regression on the data collected for the time period 2007 – 2010, they find that BVPS is more value relevant to share prices as compared to EPS.

Sibel Karğın (2013) examined “the Impact of IFRS on the Value Relevance of Accounting Information”. Data is collected for the period 1998 to 2011 from the listed companies of Istanbul Stock Exchange (ISE). In this study, market value per share (MVPS) or stock prices is taken as dependent, whereas, book value per share (BVPS) and accounting earnings per share (EPS) are used as independent variables. Through OLS cross-sectional regression analysis, it is found that the value relevance of book value has increased as compared to the value relevance of earnings per share.

Sami and Zhou (2004) investigated the value relevance of accounting information for A-share and B-share investors in Chinese Stock Market. The two main variables used as proxy for accounting information are Book value per share (BV) and Earnings per share (E). Data for 401 A-shared and 401 B-shared companies is collected. Applying GLS and Pearson Correlation co-efficient technique, results of this study indicate that accounting information is value relevant for both A-share and B-share investors but investors mostly rely on BV.

Shehzad et al., (2014) studied the impact of accounting information on stock prices. This study includes the sample of 19 private banks listed on Karachi Stock Exchange (KSE). Data is collected for the period 2008 – 2012. Share price is taken as dependent variable whereas EPS and BVPS are used as independent variables in this study. Applying pooled regression technique, it is found that EPS is more related to stock prices as compared to book value.

Azeem and Kouser (2011) studied the impact of International Accounting Standards on the value relevance of accounting information. They took sample of 52 non-financial public limited companies which are listed on Karachi Stock Exchange and are largest by market capitalization. They applied regression analysis on the financial data of selected companies for the years 2002 – 2009. Empirical analysis of this study indicates that International Accounting Standards have impact on the value relevance of accounting information i.e. by adopting International Accounting Standards, value relevance of accounting information has improved.

Ghayoumi et al., conducted research on the factors that have impact on the value relevance of accounting information. They took final sample of 106 companies listed on Tehran Stock Exchange for the period 2001 - 2007. Variables of this study include, being profitable or loss generating, company size, earnings stability and company growth. Ohlson Model and cumulative regression analysis is used in this study to examine those factors. Findings of this study indicate that above mentioned factors are value relevant to accounting information.

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Chen et al., empirically examined whether accounting information is value relevant in emerging Chinese stock market. They took sample of all listed firms in Shanghai and Shenzhen Stock Exchanges with available data for the time period 1991 – 1998. Based on return and price model, results of this study indicate that accounting information has relevance to investors in Chinese Stock Market.

  1. Literature Gap

From the historical background of the study it is clear that there is weak evidence on such study in Pakistan. Recently, in 2014 a study was conducted by Shehzad et al., on the value relevance of accounting information and its impact on share prices focusing the banking sector of Pakistan but they did not considered whether the explanatory power of variables explaining accounting information has changed over time or not. Similarly, there are some studies conducted on the accounting developments, like Ashraf and Ghani (2005). This study did not include the empirical and econometrical analysis. The focus of current study will be on the value relevance of accounting information explaining whether their explanatory power has changed over time or not.

  1. Proposed Research Model:

In this study, value relevance of accounting information will be estimated using Ohlson’s (1995) model. It expresses the stock price as a function of the earnings per share and the book value per share, as follows:

Pit = α0 + α1 Eit + α2 BVit + eit (1)

Where,

Pit = Price per share

Eit = Earnings per share

BVit = Book value per share

This model explains the joint explanatory power of the two variables i.e. Earnings per share and Book value per share. To some extent, these two variables act as substitutes for each other and can cause the problem of multicollinearity. In order to avoid this problem, the above equation is splitted into two:

Pit = β0 + β 1 Eit + eit (1.1)

And,

Pit = γ0 + γ1 BVit + eit(1.2)

These three models will have different coefficients of determination:

R2T = coefficient of determination of (1) which jointly reflects the explanatory power of earnings and book value:

R2E = coefficient of determination of (1.1), expressing the explanatory power of earnings per share, and

RBV = coefficient of determination of (1.2), expressing the explanatory power of book value per share.

The incremented explanatory power of the book value (R2 BVI) and earnings (R2 EI) are given by the following relationships:

R2 BVI = R2 T - R2 E (1.3)

R2 EI = R2 T - R2 BV (1.4)

The explanatory power that is common for both earnings and book values (R2C) is the result of the multiple model coefficient of determination less the above two parameters (R2 BVI, R2 EI):

R2C = R2 T – ( R2 EI + R2 BVI ) (1.5)

The above technique, which was proposed by Easton (1985) and Collins, Maydew and Weiss (1997) and applied by Theil (1971), examine whether the relevance of book values has changed over the years. The coefficients of determination of above equations are related to time variable as:

R2t = λ0 + λt (Time)t + ϵt(1.6)

Where, Time = 1,2, ……, 14

If λ1 is negative, it shows that explanatory power of the variables has declined over time, whereas, if λ1 is positive, it means explanatory power has increased over time.

Combining the equations from (1.3) – (1.5), the following relationship is derived:

R2C = R2 T – ( R2T+ R2 BV ) - ( R2 T + R2 E ) (1.7)

= ( R2E + R2 BV ) - R2 T

If combined R2 (R2C) increases with time, it means that EPS and BV are acting as substitutes for each other and hence there will be problem of multicollinearity.

  1. Hypothesis

H1: Accounting information has significant impact on Stock Prices

H2: Combined explanatory power has increased over time

  1. SAMPLE AND DATA

For the purposes of this study, sample of top 25 companies listed in the Karachi Stock Exchange (KSE) will be selected for the period 2000 to 2013. Required data will be collected from the secondary source i.e. from the annual reports of the companies and the balance sheet analysis reports for joint stock companies issued by the State Bank of Pakistan. For each company, the logarithms of the yearly stock prices, earnings per share and book values per share will be used throughout the examined period applying pooled regression technique.

  1. METHODOLOGY

Value relevance is measured in many ways; however there are three major types. This classification is used by many e.g., Lambert (1996) and Holthausen and Watts (2001).

  • Relative association
  • Incremental association
  • Marginal information content

Relative association studies find the value relevance in two different accounting paradigms. Usually higher R-squared is categorized as more value relevant.

Second type is the use of a set of some financial numbers in the regression analysis to predict share prices and then if regression coefficient is significantly different than zero, it is assumed that these variables are value relevant.

Third Marginal information content technique finds that how much increase in information available to the investors comes by adding another accounting measure.

Current study is based on Relative Association and Marginal Information Content Technique i.e. we will compare R2 of the regressions and also see if there is some change in information by using time as another factor. REFERENCES

Ashraf, J., & Ghani, W. I. (2005), “Accounting development in Pakistan”,The International Journal of Accounting,40(2), 175-201

Azeem & Kouser (2011), “International Accounting Standards and Value Relevance of Book value and Earnings: Panel study from Pakistan”, International Journal of Contemporary Business Studies, Vol: 2, No: 9.September, 2011 ISSN 2156-7506

Chen et al., (2001), “Is accounting information value-relevant in the emerging Chinese stock market?”, Journal of International Accounting, Auditing & Taxation 10 (2001) 1–22

Collins, D.W., Maydew E.L., & Weiss I. (1997), “Changes in the value-relevance of earnings and book values over the past forty years”, Journal of Accounting and Economics, 24, 39-67

Easton, P. (1985), “Accounting Earnings and and Security Valuation: Empirical Evidence of the Fundamental Links”, Journal of Accounting Research, Vol. 23, Studies on Accounting Earnings and Security Valuation: Current Research Issues, 54-77

Elisa et al., (2013), “Value relevance of accounting information and its impact on stock prices: Evidence from Sweden”, Term Paper

Francis, J., & Schipper, K. (1999), “Have financial statements lost their relevance?”, Journal of Accounting Research, 319-352.

Ghayoumi et al., (2012) “Factors Affecting the Value Relevance of Accounting Information”, International Journal of Academic Research in Accounting, Finance and Management Sciences, Volume 2, Issue 2 (2012) ISSN: 2225-8329

Glezakos et al., (2012), “Impact of Accounting Information on stock Prices: Evidence from the Athens Stock Exchange”, International Journal of Economics and Finance, Vol. 4, No. 2; February 2012

Hadi, M. M. (2004), “The importance of accounting information to the investors in banking sector: Kuwaiti evidence”, Working paper, College of Business Administration Kuwait University

Holthausen, R., Watts, R., (2001), “The relevance of the value-relevance literature for financial accounting standard setting”, Journal of Accounting and Economics 31, 3–75

Karğın (2013), “The Impact of IFRS on the Value Relevance of Accounting Information: Evidence from Turkish Firms”, International Journal of Economics and Finance; Vol. 5, No. 4; 2013

Keener (2011), “The relative value relevance of earnings and book value across industries”, Journal of Finance and Accountancy, 2011

Lambert, R.A., (1996), “Financial reporting research and standard setting”, Unpublished working paper, Stanford University.

Liu, J., & Liu, C. (2007), “Value relevance of accounting information in different stock market segments: the case of Chinese A-, B-, and H-shares”,Journal of International Accounting Research,6(2), 55-81

Ohlson, J. A. (1995), “Earnings, book values, and dividends in security valuation”, Contemporary Accounting Research, 11, 661-688

Oyerinde DT (2009), “Value relevance of accounting information in emerging stock market in Nigeria: The Case of Nigeria”

Sami & Zhou (2004), “A comparison of value relevance of Accounting Information in Different Segments of Chinese Stock Market”, The International Journal of Accounting, 39 (2004) 403– 427

Shehzad et al., (2014), “Value relevance of Accounting Information and its Impact on Stock Prices: Case Study of Listed Banks at Karachi Stock Exchange”, Journal of Economic Info, 3(1), 40-48, 2014

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Theil, H. (1971). Introduction to Demand and Index Number Theory. University of Chicago, Centre for Mathematical Studies, USA

Vijitha & Nimalathasan (2014), “Value relevance of accounting information and share price: A study of listed manufacturing companies in Sri Lanka”, Merit Research Journal of Business and Management, Vol. 2(1) pp. 001-006, January, 2014

Vishnani, S., & Shah, B. K. (2008), “Value relevance of published financial statements–with special emphasis on impact of cash flow reporting”, International Research Journal of Finance and Economics,17(1), 84-90.

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