«Leif Atle Beisland University of Agder Dissertation submitted to the Department of Accounting, Auditing and Law at the Norwegian School of Economics ...»
Table description Table 8 shows the value relevance of accounting information for a sample of Swedish firms in the time-period 1985 to 2004 conditioned on the stock market performance (Panel A), economic growth (Panel B) and valuation (Panel C). Each panel is divided into two parts where the first part displays the value relevance in the ten years with the highest performance, and the second part displays the value relevance in the ten years with the lowest performance. Each panel displays results for the Price model and the Return model respectively (see Table 4). Trad is the explanatory power (R2) when the model is applied to firms classified into traditional industries, and Non-trad is the explanatory power (R2) when the model is applied to firms classified into non-traditional industries. See Table 1 for industry classifications. Diff is the difference between Trad and Non-trad. Stock market performance is measured as the annual change in the AFGX index. The economic growth is measured as the annual change in GDP-per-capita, and valuation is measured as the mean equal-weighted association between market and book value of equity for all non-financial firms at the Swedish Stock Exchange.
Correlation between indicators of economic conditions:
We perform a similar analysis based on the return model specification. The results are inconclusive. Recall that the return model suggested that accounting information overall is more value relevant in the non-traditional industries. Panel A of Table 8 shows that the value relevance of both traditional and non-traditional industries decrease in periods with high market returns. The change is however similar in size and hence firms in non-traditional industries provide more value relevant information both in periods with high and low market
information, but here the difference is attributed to periods of high economic growth and high stock market valuations. Overall, measures of value relevance stemming from return model specifications appear less affected by the business environment and stock market sentiments.
The results are in the opposite direction of that in the price model specification and with much smaller magnitudes. Note that the value relevance for both traditional and non-traditional industries is lower in years characterized by high economic growth and strong market sentiments, respectively.
The price model specification supports hypotheses 3a and 3b, showing that while accounting information’s value relevance is largely unchanged over time in traditional industries, it varies substantially for the non-traditional industries. These variations are explained with the growth of the economy and market sentiments. While the return model specification does not support these relative inter-temporal variations, it suggests that both traditional and non-traditional industries experience less value relevant information with high economic growth and strong market sentiments. A firm’s value is not only determined by fundamentals related to its history, but also on expectations of the future. The influence of such other factors seems to be relatively stronger under favourable economic conditions, and it is possible that share prices deviate more from their fundamental values under the favourable economic conditions. Stock prices are limited downwards, while there is no natural limit upwards. The non-traditional sector seems to be more sensitive to the market sentiments than the traditional sector, at least when value relevance is measured with a price model specification.
Past research has suggested that one reason that the value relevance of accounting information is decreasing (if it is so?) is the growing number of firms relying largely on resources that cannot be recognized under conventional accounting standards. Using a sample of Swedish publicly listed firms we show that while the reported accounting earnings and book value of equity might appear to be less relevant in non-traditional industries this is mainly because of a greater portion of transitory earnings that can easily be captured in a model. Past research has acknowledged the different properties of positive and negative earnings (e.g., Hayn , Collins, Maydew, and Weiss , Ball and Shivakumar , Goodwin and Ahmed ). We prove that the lower value relevance is not just related to a higher frequency of losses among firms in the non-traditional industries, but also to variations in positive earnings.
To understand earnings persistence better we make a simple decomposition of earnings into a transitory and sustainable component. It is then evident that differences between the two industry categories (seen when using only reported numbers) largely depend on the transitory elements of positive earnings. It does not seem overly naïve to expect that investors also are able to separate and understand the different properties of sustainable and transitory elements of earnings. Hence past findings of differences between traditional and non-traditional firms based on reported earnings are likely to be biased.
Regardless of which model specification we use, the changes in share prices are consistently better explained by accounting information in the non-traditional industries. Our results go against most past findings in research using data from U.S. equity markets in the sense that we find no decrease in value relevance over time. However, the fairly complete dataset we use supports a growing body of international research suggesting that the value relevance of accounting information outside of the U.S. is not decreasing. From our non-U.S. perspective
from other environments: Are changes in the U.S. accounting system different from those in other countries, or could it be a change in e.g. the composition of listed firms in the U.S. that has not occurred in other countries?
A significant finding of this study is that the level of value relevance (measured as the adjusted R2) over time varies considerably more for the non-traditional industries. We find this variation to be largely unrelated to the choice of model specification, but it appears to follow a systematic pattern over time. The data reveal a negative association between value relevance and economic conditions and market sentiments. When the economy does well and investors have high hopes for the future, accounting information appears less capable of explaining security prices for firms operating in the non-traditional industries. However, when the economy slows down and stock prices decrease there is a better association between accounting numbers and share prices. This finding is not dependent on any adjustment for loss-making firms and not even the transitory component of accounting earnings.
We conclude the study by rhetorically asking what value relevance really is. Is the considerably higher variation in stock prices’ relation with accounting measures actually not a measure of value relevance? Although we can ex post identify associations between the level of value relevance and variables such as GDP-per-capita and stock returns we might not be able to predict how well accounting information will represent levels of (changes in) share prices in the coming periods. The variation in value relevance is more than twice as high for the non-traditional industries compared to traditional industries. If this is a problem, it may not be one that accounting standard setters are able to deal with. We believe it is simply an artefact of (1) a well-accepted, and to some extent irreplaceable, conservative accounting
uncertain resources. It will certainly be interesting to see the effect of the current international trend of moving towards more fair value accounting (e.g., IAS 39 on financial instruments) and more managerial discretion (e.g., IFRS 3 on business combinations). In respect of our findings, perhaps such changes to accounting systems can diminish inter-temporal variations.
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