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In this chapter, the focus of the discussion will be on those literature reviews which are relevant to this study. There are some studies which had been done in examining the relationship between the companies' performance and their stock price movement. Most of the studies which had been carried out was one but not the only of the reason that influence companies' stocks price movement.
2.1 General reviews on this study
Levine and Zervos (1998) find that that the association is particularly strong for developing countries and that various measures of stock market activity are positively correlated with measures of real economic growth across countries. Empirical evidence linking stock market development to economic growth has been inconclusive even though the balance of evidence is in favor of a positive relationship between stock markets and economic growth. Their results also show that after controlling for initial conditions and economic and political factors, the measures of banking and stock market development are robustly correlated with current and future rates of economic growth and productivity improvement.
Lam ont (1998) studies the relationship between earnings and expected returns. In his studies, he finds that higher volatility of earnings related to expected returns but is not noise. He also reports that both earnings and dividends have the ability to forecast returns. Besides, his studies also report that earnings are correlated with business conditions and these cause it to contain information.
In Shiller (1984), and Fama and French (1988)'s studies, they use regressions of returns on the lagged dividends and earnings yield as their method of studies. Their studies results show that lagged dividends and earnings yield have explanatory power. Sivakumar and Waymire (1993) study stock price behavior in relations to earning reports by using 51 NYSE firms as their scope of study. They find that the announced earnings are positively related to stock returns.
In Fama (1990) studies, he finds that the variables proxying for corporate cash flows and investors' discount rates can explained two-thirds of the variance of aggregate stocks price changes while Roll (1988) finds that less than 40% of the variance of price changes can be explained by the regressions when regresses individual stock price changes on simultaneous news events and .
Campbell and Ammer (1993) argue that the use of simultaneous regressions to explain asset price variability is appealing though this approach. The result show that macroeconomic news variables affect asset prices while Lev (1989) study result show that earnings changes are only weakly related to contemporaneous stock returns when he conducts a review of several studies on the information content of earnings and reports. Moreovers, Jin and Li (2003) also study the causes of high volatility and irrational price movements in the Chinese stock market .Their studies result identify poor disclosure and inaccurate financial reports by the listed firms as some of the causes for high volatility.
` Su (2003) analyzes the dynamic behavior of risks and returns in the Chinese stock market in his studies. He finds that some of the government policies in regards to the stock market cause to the market volatilities. He also finds that returns are positively auto-correlated to greater extent in Chinese stock markets than in developed markets and the volatility of stock returns to be high in China relative to developed markets.
Kendall (1953) observes that stock prices seem to meander randomly over time. In his studies, he test whether the past price can use to predict the future price change. Besides, his studies also expand to include others predictive variables such as financial variables. Financial variables that commonly tested to predict stock returns are the price to earnings ratio, dividend yield, book-to market ratio, return on equity, and various measures of the interest rate. However, the evidence are mixed. Although there are many empirical researches on the predicting power of financial ratios on stock returns, most of the studies are focus on the developed market like United States (US) stock market; similar studies on emerging market like Malaysia market are scant.
Kendall (1953) observes that stock prices seem to wander randomly over time, and test whether the past price can use to predict the future price change. His studies expand to include others predictive variables such as financial variables. Financial variables that commonly tested to predict stock returns are the dividend yield, price to earning ratio, book-to market ratio, return on equity, and various measures of the interest rate. However, the evidence are mixed. Although there are many empirical researches on the predicting power of financial ratios on stock returns, most of the studies are focus on the developed market like United States (US) stock market; similar studies on emerging market like Malaysia market are scant.
Apart from that, return on equity will be used as a one of the measurement for financial performance of a company as it is one of the most important indicators of a firm's profitability and potential growth. This is because it takes into consideration the three major financial components; the net profit margin, asset turnover and the equity multiplier. It measures management efficiency and effectiveness in providing return on capital used in profit generation.
According to Thompson and Yeong, 2001, return on equity (ROE) is used to measure a firm's profitability because ROE can accommodate the effect of different accounting procedure across industries and companies of different sizes as well as to minimize the multi-linearity between firm age, firm size and profitability in model building.
Changes in ROE, which represents the change in firm profitability, measures management efficiency and effectiveness in providing return on capital used in profit generation for the current year against the year before. It also expresses the increase or decrease in return on capital contributed by the legal owners of the business (Pizzey, 1980).