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Economics and Finance Review Vol. 1(8) pp. 84 – 92, October, 2011 ISSN: 2047 - 0401

Available online at http://www.businessjournalz.org/efr



Dr. Rehana Kouser (Corresponding Author)

Department of Commerce

Bahauddin Zakariya University, Multan-Pakistan E-mail: rehanakousar@bzu.edu.pk Muhammad Azeem BS (Acc & Fin) Scholar Department of Commerce Bahauddin Zakariya University, Multan-Pakistan E-mail: ranamuhammadazeem@gmail.com


International Financial Reporting Standards (IFRS) is the most conversant term in the financial reporting since the beginning of 21st century. Impacts of this adoption include the improved quality of financial reporting, less earnings management, more comparability, and high relevance for stock price determination of financial information. The statistical power to explain changes in share price and intervening impact of IFRS adoption is the focus of this research. We used two independent variables, which are book value of equity and earnings. A year by year OLS regression is used for data analysis. Study period is comprised of eight years i.e. period of 2002 to 2009. Sample of fifty two largest companies on the basis of market capitalization are drawn from the population of non-financial public limited companies listed on Karachi Stock Exchange. Study shows almost similar results in Pakistan as earlier studies of different countries empirically proved. It is proven by high values of R2 (64.33%) and Adj. R2 (62.88) in 2005. Notification of multiple IFRSs can be regarded the reason of these improved figures. Similarly in 2009 higher figures (72.94% and 71.84%) show the high relevance of accounting numbers which is the result of high quality investor oriented financial quality.

Keywords: Share Price, IAS, IFRS, Stock valuation, Earnings per share, Book value of Equity, Market Capitalization

1. INTRODUCTION Earnings and book value of equity are widely used for stock valuation. However use of accounting information in financial operations is dependent on the accounting quality of numbers. Accounting quality is determined by the reporting practices and standards. Increasing importance and popularity of International Accounting Standards (IAS) caused a wave of researches on the impacts of IAS adoption in several countries. IFRS 1 (International Financial Reporting Standards) the combination of IAS and IFRS are the pronouncements of IASB (International Accounting Standards Board) to harmonize the accounting and financial reporting practices all over the world. Proponents of IAS adoption argue that it will reduce the obstacles to global trade and capital formation from international financial markets. Due to increasing globalization and to meet challenges posed by integration of international financial markets, every country tried to adopt the integrated set of standards for financial reporting. Pakistan also adopted these standards and made reforms for compliance with IFRS. Detail about the IFRS adoption in Pakistan is provided in next sub section. IFRS adoption where influenced other areas of financial reporting and investment decisions also improved the relevance of accounting numbers in stock valuation as illustrated by many studies included in theoretical framework of the study. This relevance is often referred as value relevance or valuation relevance. This relevance is statistically measured by the magnitude of 1 IASs were issued by the former structure of IASB, the IASC (International Accounting Standards Committee). IFRS are being issued by the IASB since 2000. We used the term IFRS in the study as the combination of both.

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relationship between the share price and accounting numbers. The study targets to inspect this relationship with respect to year by year IFRS adoption by Pakistan.

1.1. IFRS adoption by Pakistan For the sake of IFRS adoption compliance, SECP (Securities and Exchange Commission of Pakistan) the regulator of local stock exchanges in Pakistan has the powers to issue notifications in this regard.These powers are included in the Companies Ordinance (CO) 1984, in section 234. The Section 234 of CO 1984 and related schedules deals with the “Preparation and presentation of Financial Statements”. However SECP is not independent in the IFRS adoption. ICAP (Institute of Chartered Accountants of Pakistan), the professional and regulatory body for Accounting and Financial Reporting, recommends the adoption before the notification by SECP. A formal process is followed by the ICAP to adopt the IFRSs in Pakistan. ICAP’s technical services department deals with the adoption. Several committees and councilsare formed for the adoption of new IFRSs.

Only companies trading publically on stock exchanges are required to comply with IFRS. ICAP has been adopting the pronouncements by IASB over previous twenty five years. However actual adoption of standards began with start of 21st century.

Pakistan has adopted all the IASs and some of the IFRSs. Decision of adoption is made between the professional and regulatory bodies in the country which include the ICAP, SECP and SBP. SBP show its involvement on the financial markets related issues, monetary policy and financial assets related tasks. For example IAS-39 Financial Instruments: Recognition and Measurementis under discussion for implementation in abeyance by State Bank of Pakistan for Banks and DFIs (Development Finance Institutions). Latest status of adoption and detailed schedule about the adoption pattern of revised IAS/IFRSs is annexed in the appendix-B.

1.2. Objectives of the Study

The study is conducted with some aims and has some motivations listed below:

 All the previous researches reviewed are conducted in a country other than Pakistan.

 No previous research, to our knowledge, investigated this issue by using year by year analysis.

 The Study of Ali & Hawang, (2000) discussed the country related factors for the value relevancy of reporting standards and argue that countries with low investor involved policies and where standard setting process doesn’t involve private bodies (like Pakistan) have low value relevance of accounting information. To test this claim is another motivation for this study.

2. LITERATURE REVIEW Literature included in the study is categorized into two parts. At first level general impacts of the IFRS adoption are listed briefly. However in the second step literature on the subject of relevance of accounting numbers especially book value of equity and earnings i.e. relationship of share price with earnings and book value of equity. There is no previous ground for literature on IFRS adoption and its impacts in Pakistan, so only literature from other countries especially US, and European countries is reviewed.

2.1. General Impacts of IFRS adoption Literature is evident of multifold impacts by IFRS adoption. Major dimensions of these impacts are relevance of accounting numbers, accounting quality, transparency (less space for earnings management), and fair value accounting practices. Furthermore, improvements in financial ratios, comparability and improved analyst’s forecasts, are also included. Important studies to quote here include Bartov, Goldberg, and Kim (2002);

Wulandari & Rahman (2004); Barth & Lang (2006); Callao, Jarne and Lainez (2007); Ding, Hope, Jeanjean and Stowoly (2007); Christensen, Lee and Walker (2007); Lantto & Sahlström (2009); Aubert & Dumontier (2009);

and García & Bastida (2010), which studies above mentioned impacts. However scope of this research is limited to the impact of IFRS adoption on relevance of accounting numbers.

2.2. IFRS adoption and Relevance of Key Accounting Numbers Accounting Standards has a great impact on the characteristics of accounting numbers. The area of value relevance and stock valuation has great attachment to the reporting practices, especially IFRS. Bartov,

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Goldbarg, and Kim (2002) compared the value relevance of US GAAP, German GAAP, and International Accounting Standards (IAS). They used regressions analysis for the sample of German companies listed in German Stock Exchange, with study period of 1998-2000. Their study concluded that value relevance of US GAAP based earnings is higher than that of IAS based Earnings which in turn is more value relevant than earnings produces under German GAAP. Callao, Jarne and Lainez (2007) focused on the effect of new standards on comparability and relevance of financial reporting in Spain. To compare value relevancy among the two set of standards Spanish and IFRS researchers used parametric and non-parametric tests with sample of 26 companies from Spanish stock exchange. Period of study was comprises of 2004 and 2005. Research found that there is an adverse effect if both IFRS and local standards are applied at the same time in the same country.

There is a gap between book value and market value which increased when IFRS is applied. Cash solvency, Indebtness ratio, and financial performance change as book value and market value differs in income statement and balance sheet. The relevance of earnings and book value isincreased when IFRS adopted.

Wulandari and Rahman (2004) examined the value relevance at country level using firm level data. Study investigated the effects of three regulatory arrangements (accounting standards’ quality, acceptability, and enforceability) and the overall accounting regulatory environment on value relevance of earnings and book value of equity. It used survey analysis and multivariate tests for the sample firms of 35 different countries.

Conclusions included value relevance, quality, acceptability and punitive enforcement of accounting standards with accounting earnings. Composite variables and regulatory environment possesses the value relevance.

Relationship between financial reporting regime and value relevance is positive and high in code law countries and emerging markets with developing economies. Beisland and Knivsfla (2009) examined that whether the shift in reporting regime from local GAAP to IFRS has changed how investors respond to accounting information (specifically Book values and Earnings). It used the regression analysis with the sample of 741 firms listed on Oslo stock exchange during the 2002-2006. Investigation concludes that association between stock prices and book value has increased after the transition to IFRS, the earnings responses coefficients have decreased. The increased association between book value and stock market value is attributed to more recognition of intangibles and more fair value measurements. Thus fair value revaluations appear to be detrimental to value relevance of earnings. Kadri, Aziz, and Mohamed, (2009) investigated the relationship between market value book value and earnings of Malaysian firms under two different financial reporting environments; MASB and FRS. This employed the Ohlson Model for 59 listed (property) firms in Bursa Malaysia; results shown significant relationship exist between market value book value and earnings. A more significant relationship between market value, book value and earnings exist during the FRS period. So in short value relevancy of Book value and Earnings were increased after the implementation of FRS and found that earnings are more value relevant than book values in FRS period.

Gastón, García, Jarne, and Gadea, (2010) examined the quantitative impact of IFRS adoption on financial reporting issued by first time adopters. Study analyzed whether relevance of financial information is higher under IFRS than the Spanish GAAPs. They used the multivariate analysis including sensitivity analysis for 174 listed companies of Madrid stock exchange for 2004 and concluded first time IFRS adoption in Spain cause higher value relevance on assets and liabilities and worse financial position. Clarkson, Hanna, Richardson, and Thompson (2011) investigated the impact of IFRS adoption in Europe and Australia on the relevance of book values and earnings for equity valuation. Both the linear and non-linear pricing models are employed. They found that 3488 firms which initially adopted IFRS in 2005, found an increased non linearity in data subsequent to IFRS adoption, for firms in common law countries with nonlinear effects there is no observed change in price relevance for firms in either code law or common law countries. However relevance of numbers has increased after adopting IFRS.

3. RESEARCH DESIGN Researches on the subject of stock valuation or more formally value relevance with respect to reporting standards are based on the quantitative research designs. Major techniques used are the pre and post based analysis, cross sectional analysis, or time series analysis. This study uses the last mentioned technique to check the trends in the relationship of share price with earnings and book value of equity. As mentioned in the

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literature, there is less or no development of the literature on the issue of IFRS and impacts in Pakistan. We chose to study the impacts of IFRS adoption in Pakistan using a year by year analysis approach, due to complex and unclear pattern of IFRS adoption by ICAP.

The study employs the three variables of the study which include one dependent and two dependentvariables.

The dependent variable is equity price which is measured using the proxy MVPS (Market Value per Share).

Independent variables consist of the earning and book values of equity, which are measured using the proxy of EPS (Earnings per Share) and BVPS (Book value per Share). There variables are used due to increased popularity in stock valuation, shown by literature included in the study.

So in this way research model can be shown mathematically as follows:

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The research is aimed to answer following research question:

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