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    2015 Chapter 05-Ppt Scot Bab 5

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    This chapter discusses how accounting information is evaluated based on how much security prices change in response to that information. It outlines how studies measure the value relevance of accounting information by examining abnormal stock returns around earnings announcement dates. The seminal Ball and Brown study from 1968 is summarized, which found stock prices react to unexpected earnings in the month of announcement. Subsequent research estimated earnings response coefficients to examine how stock returns relate to unexpected earnings amounts and qualities like persistence. The chapter notes factors like risk, capital structure, and growth that influence coefficients and how policies with higher coefficients provide more decision-useful information.

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    2015 Chapter 05-Ppt Scot Bab 5

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    AGA
    83 views26 pages
    This chapter discusses how accounting information is evaluated based on how much security prices change in response to that information. It outlines how studies measure the value relevance of accounting information by examining abnormal stock returns around earnings announcement dates. The seminal Ball and Brown study from 1968 is summarized, which found stock prices react to unexpected earnings in the month of announcement. Subsequent research estimated earnings response coefficients to examine how stock returns relate to unexpected earnings amounts and qualities like persistence. The chapter notes factors like risk, capital structure, and growth that influence coefficients and how policies with higher coefficients provide more decision-useful information.

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    This chapter discusses how accounting information is evaluated based on how much security prices change in response to that information. It outlines how studies measure the value relevance of accounting information by examining abnormal stock returns around earnings announcement dates. The seminal Ball and Brown study from 1968 is summarized, which found stock prices react to unexpected earnings in the month of announcement. Subsequent research estimated earnings response coefficients to examine how stock returns relate to unexpected earnings amounts and qualities like persistence. The chapter notes factors like risk, capital structure, and growth that influence coefficients and how policies with higher coefficients provide more decision-useful information.

    Copyright:

    © All Rights Reserved
    Download as PDF, TXT or read online from Scribd
    Download as pdf or txt
    83 views26 pages

    2015 Chapter 05-Ppt Scot Bab 5

    Uploaded by

    AGA
    This chapter discusses how accounting information is evaluated based on how much security prices change in response to that information. It outlines how studies measure the value relevance of accounting information by examining abnormal stock returns around earnings announcement dates. The seminal Ball and Brown study from 1968 is summarized, which found stock prices react to unexpected earnings in the month of announcement. Subsequent research estimated earnings response coefficients to examine how stock returns relate to unexpected earnings amounts and qualities like persistence. The chapter notes factors like risk, capital structure, and growth that influence coefficients and how policies with higher coefficients provide more decision-useful information.

    Copyright:

    © All Rights Reserved
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    of 26

    Financial Accounting Theory

    Seventh Edition
    William R. Scott

    Chapter 5
    The Information Approach to Decision
    Usefulness
    Chapter 5 The Value Relevance of Accounting Information
    5.1 The Value Relevance Approach

    Assumes securities market efficiency


    Investors responsible for predicting future firm performance
    Role of financial reporting to provide useful information for this
    purpose
    Usefulness of financial statement information evaluated by
    magnitude of security price response to that information
    Helps accountants to evaluate decision usefulness of different
    accounting policies
    5.2. Outline of the Research Problem

    Reasons for market response


    An application of decision theory model
    Investors have prior probabilities of future firm performance
    Investors obtain useful information from financial statements
    Investors revise their probabilities
    Leads to buy/sell decisions
    Security price and share return change

    >> Continued
    Outline of the Research Problem (continued)

    Abnormal share return


    Most value relevance studies examine effect of earnings information
    on return on firms common shares
    Total share return = return due to market-wide factors abnormal
    return due to firm-specific factors
    Abnormal share return can be attributed to financial accounting
    information
    If good news in financial statements leads to positive abnormal share
    returns (and vice versa), conclude financial statement information is useful.
    To reach such a conclusion, need to separate market-wide and firm-
    specific share return

    >> Continued
    Outline of the Research Problem (continued)

    Separating market-wide and firm-specific returns


    Firm releases financial information
    Most studies look at release of earnings
    Use a market model to estimate market-wide return on that day (or
    narrow window)
    Assumes market efficiency
    Abnormal share return during narrow window = total return market-
    wide return
    See Figure 5.2

    Continued
    Outline of the Research Problem (continued)
    Outline of the Research Problem (continued)

    Unexpected earnings
    Investors have expectations of current earnings
    Investors expectations are built into share price prior to release of
    current earnings
    Assumes market efficiency
    When current earnings released, investors will react only to unexpected
    component
    Investors earnings expectations unobservable
    How to estimate unexpected earnings?

    >> Continued
    Outline of the Research Problem (continued)

    Estimation of investors earnings expectations


    Time series approach
    Based on earnings in prior years
    Analysts forecasts
    Available for most large firms
    Now the most common approach
    Outline of the Research Problem (continued)

    Finally, compare abnormal share return with unexpected


    earnings
    If positive unexpected earnings is correlated with positive abnormal
    share return, and vice versa, suggests earnings information is decision
    useful
    5.3 The Ball and Brown Study

    The first study to document statistically a share price


    response to firm-specific component of reported net income
    (1968)

    Methodology still in use today


    The Ball and Brown Study (continued)

    B&B methodology
    For Each Sample Firm:
    Estimate investors earnings expectations (proxied by last years actual)
    Classify each firm as GN (actual earnings > expected earnings) or BN (vice
    versa)
    Estimate abnormal share return for month of release of earnings (month
    0), using procedure of Figure 5.2

    Continued
    The Ball and Brown Study (continued)

    B&B methodology (continued)


    Calculate Average Abnormal Share Return for GN Firms in the sample
    for Month 0
    Ditto for BN Firms
    Repeat for Months -1, -2,,-11, and Months +1, +2,,+6
    Plot Results
    See Fig. 5.3, next slide
    B&B Results
    The Ball and Brown Study (continued)

    B&B conclusion
    Stock market reacts to earnings information in month zero, but begins
    to anticipate the GN or BN in earnings 12 months prior
    Consistent with securities market efficiency and underlying rational
    decision theory

    >> Continued
    The Ball and Brown Study (continued)

    Causation v. association
    Narrow Window Studies
    Evidence that financial statement information causes security price change
    B&B month zero is narrow window
    Wide Window Studies
    Evidence that financial statement information is associated with security
    price change
    B&B months -12 to -1 and 1 to 6 are wide window
    Narrow window studies more consistent with decision usefulness
    >> Continued
    The Ball and Brown Study (continued)

    Research in years following Ball & Brown


    Does amount of abnormal share price change correlate with amount of
    GN/BN in earnings?
    Amount of GN/BN = expected earnings - actual earnings
    Answer: Yes
    With quarterly earnings reports? Yes
    On other stock markets? Yes
    5.4 Earnings Response Coefficients

    A different question
    Does quality of earnings affect magnitude of abnormal share return?
    Conceptually, quality of earnings is measured by the main diagonal
    probabilities of the information system
    Higher main diagonal probabilities implies higher quality
    In practice, earnings quality often measured by:
    Earnings persistence
    higher persistence higher quality
    Accruals quality
    DeChow & Dichev (2002)): higher accruals quality higher earnings quality
    Definition of ERC

    An earnings response coefficient (ERC) is


    abnormal share return divided by unexpected
    earnings
    That is, ERC is abnormal share return per dollar of
    unexpected earnings
    Question then is
    Does higher earnings quality result in higher ERC?
    For earnings quality measured by persistence: Yes
    For earnings quality measured by accruals quality: Yes

    5 - 19
    Earnings Response Coefficients (continued)

    Characteristics affecting ERC


    Risk (): higher lower ERC
    Capital structure: higher D/E lower ERC
    Earnings quality:
    higher quality higher ERC
    Important components of earnings quality
    Earnings persistence:
    higher persistence higher ERC
    Accruals quality
    DeChow & Dichev (2002)): higher accruals quality implies higher earnings quality

    >> Continued
    Earnings Response Coefficients (continued)

    Factors affecting ERC (continued)


    Growth opportunities: higher opportunities, higher ERC
    Similarity of investor expectations: more similar, higher ERC
    Informativeness of price: more informative, lower ERC
    Firm size as proxy?

    >> Continued
    Reasons for Studying ERCs

    ERC research has greatly improved accountants


    understanding of how market responds to reported earnings
    Better understanding enables preparation of more useful
    financial statements
    E.g., Financial reporting policies that produce a higher ERC are more
    decision useful for investors

    5 - 22
    5.4.3 Measuring Investors Earnings Expectations

    Time series approach


    Depends on earnings persistence
    Earnings 100% persistent
    Unexpected earnings = change in earnings
    Earnings zero persistence
    Unexpected earnings = current years earnings
    Analysts forecasts approach
    Evidence suggests more accurate than time series
    Unexpected earnings = analyst forecast error
    Older forecasts tend to be less accurate
    Are analysts biased?

    5 - 23
    A Caveat about the Best Accounting Policy (continued)

    While accounting policies that produce the highest ERC may


    be most decision useful for investors, they may not be best
    for society
    Accounting information as a public good
    Investors who do not pay for accounting information will demand
    more of it than socially desirable
    Implication is that standard setters cannot be sure that an accounting
    policy that has a higher ERC than another is socially better.
    Complicates standard setting
    5.6 Value Relevance of Other Financial
    Statement Information
    Balance sheet
    Hard to find since more difficult to know when investors first become
    aware of B/S information

    Supplementary information
    RRA: mixed evidence
    Financial statement notes
    Evidence of market response following the date firms report to SEC
    Response driven by financial analysts who pounce on the data
    MD&A:
    Li (2010), Section 3.6.4
    Brown & Tucker (2011), Section 3.6.4

    5 - 25
    5.7 Conclusion

    Security market response to accounting information supports


    rational decision theory and efficient securities market theory

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