accounting research (ROUGH DRAFT ONLY): CAPITAL MARKET RESEARCH: FOCUS ON ACCOUNTING INFORMATION AND ITS EFFECT TO SECURITY PRICES

7/30/2019 accounting research (ROUGH DRAFT ONLY): CAPITAL MARKET RESEARCH: FOCUS ON ACCOUNTING INFORMATION AND ITS EFFECT TO SECURITY PRICES

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Capital Market ResearchAccounting in the eyes of the decisionmakers

IRINCO. GANIA. AFAGA. DEL ROSARIO. MOLO. MONTES. POMAREJOS.SANTOS 2013


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IMPORTANCE OF CAPITAL MARKET RESEARCH

INTRODUCTION


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WHY CAPITAL MARKET?

DOMINANTuser of accountinginformation . . . and other usersHAVECOMMONALITY OF

INTEREST with creditors andinvestors

INTRODUCTION


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Focus on investors andcreditors interestin amounts. Uncertainty and future cashflows

INTRODUCTION


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accounting aims at providing

investors with relevant informationfor investment, decision making and

enabling investors to predict future cash

flows and assess future risk and returns

associated with particular shares..inamounts. Uncertainty and future cash

flows

INTRODUCTION


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INTRODUCTION

BIG QUESTION?


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MODELS

GORDON DIVIDEND VALUATION MODEL

Accounting income

indirectly assesssecurity price value


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f(future dividends) = security price

f(future earnings) = future dividendsf(accounting earnings) = future earnings

MODELS

Future

dividends

Future

earnings

Accounting

incomeSecurity price

GORDON DIVIDEND VALUATION MODEL


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**dividendinstead a function ofearnings is a matter ofcorporate

policy

MODELS

BEAVERS IDEA USING GORDON DIVIDEND

VALUATION MODEL ISSUE


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tax effects,

Value of firm = PV of net cash flows

MODELS

MILLER AND MODIGLIANI

MORE DIRECT


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EFFICIENT MARKET HYPOTHESIS

EMH DEFINED

A market in which prices at any

time fully reflect

available information iscalled efficient (FAMA)

..beating the market is impossible


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EMH SCRUTINIZED


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EMH BASIS

microeconomic price

theory (emphasis on supply anddemand, equilibrium and competitive

markets. ).

**MC = MR

- Impossible on average to earn pureeconomic profits by trading on this

information.


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EMH CONDITIONS

1) There are no transaction

costs in trading securities

2) All information is available cost-freeto all market participants

3)All agree on the

implications of currentinformation for the current price and

distributions of future prices of each

security


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DIFFERENT INFORMATION SETS

Strong (all information: private +

public +past prices)

Semistrong (all

publicly available

+past prices)

Weak form (past

prices)


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RANDOM WALK HYPOTHESIS

-views market prices as random and so

impossible to predict

-tomorrows price change will reflect onlytomorrows news

-both fundamental analysis and technical

analysis are wastes of time


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CRISIS IN CMR AND EMH/ISSUES

DIFFICULTIES IN CONDUCTING CMR

A) Price continuous adjustment

B) Accounting information is tough to

isolate from the other set of informationaffecting security prices

C) Joint test of market efficiency and

information content

D) An aggregate effect instead of

individual


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FUNDAMENTAL ANALYSIS

Conducted by Ou and Penman.

WHY?

FUND. ANALYSIS VS.SEMISTRONG EMH

**argument: MARKET INEFFICIENT,

presence of abnormal earnings

Suggestion by WOLK, TEARNEY, DODD:

BETTER ACCOUNTING STANDARDS


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COSMETIC ACCOUNTING

Conducted by KAPLAN AND ROLL

*no-effect hypothesisno effect on

cash flows, no abnormal earningswhen accounting change is cosmetic only(a joint hypothesis, to CAPM, EMH and zero

monitoring costs)

*mechanistic hypothesisthere isabnormal earnings at date ofannouncement

**market was fooled


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EARNINGS AND STOCK RETURNS

Conducted by BARUCH LEV to establish

relationship of earnings and stock return.

**argument: Low quality of reported

income numbers

Research on quality ofearnings..calling for

systematic examination of the extent by which

specific principles, underlying accounting

measurements and valuations as well as

managerial manipulations detratc usefulness of

earnings and financial variables..


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PRICE LEAD EARNINGS

Earnings lags to prices because prices

contain information about future earnings.

Argument: due to conservatismin revenue realization and expensematching (deficient-GAAP

argument)**doubts on ACCRUALS vs. CASH FLOWS


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POST EARNINGS DRIFT ANNOUNCEMENT

POST DRIFT vs. SPEED IN ADJUSTMENT

THEORY OF EMH

Takes up to 60 DAYS for price to adjust

**argument: financial analystunderreaction


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TIMELINESS OF ACCOUNTING

INFORMATION

**Interim lead for the investors to predict

annual reports earnings

**larger firms under scrutiny by financialanalysts.

**argument: decreasing

relevance, accounting asconfirmation


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INVESTORS LOVE CASH FLOW

RICHARD SLOAN: cash flow persist longer

to future and is subject to less

manipulation


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OTHER ANOMALIES

1)Exchange effect: interestand information vary on market

2)Exotic effect: eom, eoy,weeked, yom kippur and January effect

3)Neglect effect4)Small firm effect


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ROBERT BLOOMFIELDS IRH

INCOMPLETE

REVELATION

HYPOTHESIS

**some accounting numbers

uncovered**presence ofnoise traders


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BEHAVIOURAL FINANCE + ALTERNATIVES

BEHAVIOURAL FINANCE

DEFINED

The used ofpsychology-

based theories to analysestock market anomalies and investing

decisions.


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ARE SECURITY MARKETS FULLY EFFICIENT?

Behavioural characteristics that

question market efficiency:

1) Representativeness

2) Herd Behaviour

3) Overconfidence

4) Overreaction and Availability bias


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Representativeness refers to the tendency

to form judgments based on

stereotypes.

REPRESENTATIVENESS DEFINED


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Herd behavior represents the preference for

individuals to mimic the behaviors or

actions of a larger sized group.

HERD BEHAVIOR DEFINED


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Overconfidence represents the tendency foran investor to overestimate his or her

ability in performing some action/task.

Overreactionoccurs when one reacts to apiece of news in a way that is greater

than actual impact of the news.

OVERREACTION AND OVERCONFIDENCE


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Expresses value of firm in terms

of accounting variables

**Firm value = net assets present

value of future abnormal earnings

ALTERNATIVES TO EMH: OHLSON CLEAN SURPLUS

THEORY


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VALUE RELEVANCE

RELEVANCE

Qualitative

characteristics of financialstatements

**the ability of the financial statements to

influence users

decisionsamounts. Uncertainty andfuture cash flows


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VALUE RELEVANCE

VALUE RELEVANCE DEFINED

An accounting number is Value Relevant if

it conveys information

that results in themodification of

investors expectationsabout future payoffs or associated risks

amounts, uncertainty and future cash

flows(Bart, Beaver and Landsman, 2001)


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VALUE RELEVANCE

VALUE RELEVANCE LITERATURE

DEFINED

examines the relation between stock

market and a particular accounting

variable where that variable is defined as

value relevant if it exhibits a

predicted association

with equity marketvalue(Holthausen and Watts,2001)


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VALUE RELEVANCE

ISSUES LIMITING STANDARD SETTING

INFERENCES FROM CMR

a) standard setters face an extremely difficult task in terms of meeting the

informational requirements of the diverse group of financial statement users

b) the literature has not provided very strong results in terms of the association

between stock returns and accounting earnings

c) the influence of externalities complicates the analysis and conclusions

reached in capital market research

d) the terms of relative sophistication of market participants

e) the different incentives the standard setters have to researchers in terms of

research questions, the timing of the research output and the focus of a given

study


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VALUE RELEVANCE

RESEARCH METHODS: EVENT STUDY

it inferred whether a given event provides

relevant new information to the market by

aligning sample stocks

in event time and examining thestock price performance around the event

(Brown and Warner,1985)

**Earnings Announcements- relationship between unexpected

earnings and changes in stock prices


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VALUE RELEVANCE

RESEARCH METHODS:ASSOCIATION STUDY

used to test the positive correlation between

stock returnsand an accounting

measure of performance in longwindow (usually annual) contemporaneous

time periods (Ball and Brown, 1968)

**POST ANNOUNCEMENT DRIFT


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VALUE RELEVANCE

ERC (EARNINGS RESPONSE COEFFICIENT)

measured as the slope coefficient

(sensitivity) in an

earnings-returnsregression

**R2

(goodness of fit)is ameasurement of the informationcontribution of the independent variables


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VALUE RELEVANCE

FOUR COMMONLY SIGHTED THEORIES/ISSUES:

a)price leads earningsthe findingthat earnings lag prices because prices

contain information about future earnings

b) result of ERC in inefficient markets

c)accounting earnings figure is

not the true earnings of agiven firm

d) the impact of transitory earnings


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VALUE RELEVANCE

VALUE RELEVANCE OF COMPONENT EARNINGS

No evidence that components ofrevenues or expenses had

incremental information

content over earnings(Wilson,1986 and Hopwood and McKeown,1985)


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VALUE RELEVANCE


The use of analysts forecastas proxy for markets

expectations was driving difference inresults through assessment on the

information content of revenues andexpenses (Swaminathan and Weintrop,1992).


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VALUE RELEVANCE


Issue of how well the disaggregated

components of earnings explain stock

returns was also tested by Ohlson and

Penman.

Components examined:

Gross margin

Tax expense

Operating ExpensesDepreciation expense

Extraordinary items

Other income/expense items


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VALUE RELEVANCE

ACCRUALS VS. CASH FLOW

Dechow (1994) uses this disaggragatingapproach to assess whether accrual

earnings is a superior measure of

firm performance to cash flows


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VALUE RELEVANCE

ACCRUALS VS. CASH FLOW: IN FAVOR OF ACCRUALS

Subramanyam (1996) looked at the pricing

of discretionary accruals and found

that they increase the

information content ofaccounting information


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VALUE RELEVANCE

ACCRUALS VS. CASH FLOW: IN FAVOR OF CASH FLOWS

The ability of managers to use discretionary is a

double-edged sword, Easton (1996).

1.Comparability of earnings

across firms is poor due to variances inthe application of accounting policies.

2. Managers ability to manipulate

accruals.3. Accounting earnings can result inpoor

investment decisionsdue to points 1and 2.


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VALUE RELEVANCE

ACCRUALS VS. CASH FLOW

Earnings are more important than cash flows

in most situations, except for when earningsare transitory, and that combined earnings

and cash flows have significant information

content as shown by Cheng, Lui, and

Schaefer (1996).


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VALUE RELEVANCE

ACCRUALS VS. CASH FLOW:AGAINST CASH FLOW

Ali and Pope (1995)concluded that cash

flowsdo not contain

incremental informationabove earnings, and are a little use

in pricing assets by improvingthe research design by Board amd Day

(1989).


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ACCOUNTING DIVERSITY EFFECTS TO CMR

ACCOUNTING DIVERSITY-variability in financial statements due to

differences in national context

**How does it affects

the accounting

information?


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ACCOUNTING DIVERSITY

Desirability ofaccounting

harmonization


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HOW ACCOUNTING DIVERSITY AFFECTS CMR?

Accounting information is mostly

based on the analysis of the

analyst..

The differences contibutes to a

difficulty of making a global study

in CMR


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INTRODUCTION

BIG QUESTION?


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DECLINING RELEVANCE

CONTRIBUTING FACTORS TO DECLINING RELEVANCE

BUSINESSCURRENCY

EXPOSURE

SOPHISTICATION

OF INVESTORS

TECHNOLOGICAL

DEVELOPMENT


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DECLINING RELEVANCE

ASSOCIATION OF STOCK PRICES WITH ACCOUNTING

INFORMATION: DIVIDENDS

dividends as a measure of businessperformance and as a standard method of

valuing shares.


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DECLINING RELEVANCE

ASSOCIATION OF STOCK PRICES WITH ACCOUNTING

INFORMATION: EARNINGS AND BOOK VALUES

the value relevance of accounting numbers

(such as earnings and book values)

decline in contemporaneous

associations between theaccounting numbers and stock prices


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DECLINING RELEVANCE

INCREASING RELEVANCE OF SFP

**earnings contain an increasing

level of transitory

components and hence book valueserves as a better proxy for future returns

**book values also proxy for the firms

abandonment option, therefore, increasing invalue relevance


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Capital Market ResearchAccounting in the eyes of the decisionmakers

accounting research (ROUGH DRAFT ONLY): CAPITAL MARKET RESEARCH: FOCUS ON ACCOUNTING INFORMATION AND ITS EFFECT TO SECURITY PRICES

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