Examining the relation between stock prices and earnings in a transition economy

The intent of this paper is to analyze the relation between stock monetary values and net incomes in a passage economic system. The value relevancy of accounting information has a long history of research patterns largely known as association surveies. The principle behind this type of surveies is to measure whether accounting informations provide dependable information for investors. Harmonizing to ( Dumontier & A ; Raffournier, 2002 ) association surveies ‘posit that if accounting informations are good drumhead steps of the events incorporated in security monetary values, they are value-relevant because their usage might supply a value of the house that is near to its market value. The presence of value relevancy of accounting informations is given by high correlativities with stock monetary values or returns and can besides be interpreted as the explanatory power of net incomes over the alterations in equity values.

International accounting organic structures developed an investor based orientation of the accounting criterions, stressing the importance of fiscal coverage and revelations for a good working market. Besides we observe an increasing influence of the international accounting criterions in hurt of local GAAP ‘s taking finally to a convergence procedure. Obviously the impact of IFRS is different in every state due to specific factors and measuring it for farther betterments is a existent challenge for regulators. This is peculiarly of import for passage economic systems in which accounting reforms are implemented within a comparatively short period of clip. These surveies provide valuable grounds about the impact of the accounting ordinance on fiscal markets and asses the quality and dependability of accounting Numberss for investors.

Association surveies were largely conducted in mature developed markets such as US and Western Europe and the grounds, based on weak dealingss estimations, suggests that net incomes are non a dependable step of the events incorporated in stock monetary values. One possible account would be that net incomes are non timely steps used to gauge future hard currency flows and they besides reject those events that do non follow with accounting ordinance in order to be recognized in the accounting informations. In the same clip investors focus on all type of information available when measuring their investment options. For this ground stock monetary values reflect events in a timelier mode than accounting information does.

However the reproduction of this survey in an emerging state might take to interesting deductions due to its specific features. Harmonizing to ( Harrison & A ; Paton, 2004 ) ‘Transition describes the procedure of transforming an economic system from program to market and implies coincident disruptions in economic behaviour and major alterations in multiple facets of the economic system ‘ . I chose Romania as the sample state for my survey because it followed the specific forms of a passage economic system. After the communism prostration in 1989 it has experienced multiple legislative and accounting reforms along with a big scale denationalization procedure.

There are several factors proposing that accounting information is less relevant for an emerging capital market than it is for a mature market. One of these factors is the accounting system. Hellestrom, ( 2006 ) considers ‘the quality of the accounting Torahs and ordinances, the primary requirement of value relevancy ‘ . At the beginning of passage procedure it is expected that the undeveloped accounting model may bring forth hapless quality accounting information. One interesting facet that can be studied in a passage context is the development of value relevancy information as a consequence of the accounting ordinances reforms and betterments. In the instance of Romania accounting reforms culminated with the acceptance of IFRS in 2006/2007 imposed by the attachment to European Union. Theoretically this should take to an addition of accounting informations relevancy. When measuring value relevancy based on the quality of accounting model one must take into consideration the mechanisms used by a state to coerce companies comply with accounting ordinances. Control mechanisms lacked in the first portion of passage in Romania. However they developed bit by bit: Bucharest stock exchange adopted a codification of corporate administration in 2002, the demands for naming became stricter, accounting and scrutinizing patterns were improved, supervised and regulated by national organisations.

Another factor would be represented by the comparatively new capital markets characterized by a short history of trading, little figure of companies and low liquidness. We can besides deduce a comparatively weak efficiency of the market that may act upon negatively the earnings-returns dealingss. ‘If the market fails to correctly appreciate the deductions of a current net incomes surprise in revising its outlooks of future net incomes, the monetary value alteration associated with net incomes alteration will be excessively little ‘ . ( Kothari, 2001 ) . Bucharest stock exchange was established in 1995 and in the first old ages of trading was characterized by a little capitalisation, thin trading and few companies. However, in 2000 the form radically changed due to inflow of capital from foreign investors.

Furthermore, in passage economic systems Bankss represent the prevailing beginning of finance. Because of the close relation between companies and Bankss the demand for accounting information is lower than in states in which financess are raised through good developed capital markets.

On the other manus, Filip & A ; Raffournier, ( 2010 ) supply a good account for a higher value relevancy in a passage economic system. Due to a weak presence of intermedieries such as fiscal analysts or economic imperativeness, investors are forced to trust on fiscal statements doing accounting information more relevant than in developed economic systems where the battalion of information beginnings make the accounting informations outdated.

Taking into consideration the specific features of a passage economic system such as Romania, association survey employed is supposed to uncover of import information about the efficiency of capital market, the perceptual experience of investors on the accounting information every bit good as the impact of the accounting reforms on the overall operation of capital market.

Data aggregation

The sample consists of the companies listed on Bucharest stock exchange which is the chief trading system in Romania. The listed companies are assigned to one of the three classs the market has harmonizing to some fiscal standards like size, net income, liquidness. The companies in the first class meet stricter demands of fiscal public presentation, corporate administration and size than the others. In the 2nd class we find smaller companies with hapless fiscal consequences which still meet a sensible grade of hazard. There is besides a class for international companies. BSE has a 2nd market called Rasdaq that has the features of an OTC market with the companies listed being riskier and less efficient.

I selected the companies listed in the first two classs of BSE. Due to these demands I can deduce a better efficiency of the market, higher transparence and liquidity. ( ? ? ? statement for this ) I rejected the international subdivision because at the minute it contains merely one company. The information was collected through Thomson One Banker database every bit good as from BSE web site.

Because the association survey implies a long term relation between market informations and accounting Numberss I chose to detect the sample of companies over 5 old ages from 2005 to 2009, which is the most recent minute with available information. I chose 2005 as the starting point because in this twelvemonth the pact for accession to European Union was signed and the authorities imposed new regulations in order to aline the national ordinance with the international demands. The accounting reforms focused on following and implementing IFRS ‘s which became mandatary from 2007 onward.

The figure of companies listed on BSE varied somewhat within this period. 3 companies were delisted in 2007-2009 making a entire figure of 103 at the terminal of the last twelvemonth. I withdrawn fiscal establishments because typical accounting regulations are applied in their instance. Furthermore, 26 companies were unlisted during this period. Harmonizing to BSE website unlisted companies are a distinguishable class of companies which belong neither to BSE nor to Rasdaq. They do non follow any longer with the demands imposed but the authorization allows them to be traded within the system. After the mentioned accommodations the sample reached an norm of 67 companies. The companies in the first class represent about a one-fourth of the entire sample. Table1 presents the distribution in the two classs along the period.The sample has companies from the bulk of industries, distributed in a comparatively equilibrate proportion. Fabrication and metallurgy are the most outstanding industries with 24 % and 13 % severally. Energy providers are besides good represented along with chemical industry. Food, transits, retail and heavy industry have the same proportion of 6 % . Table 2 presents the distribution of the sample companies by industry.

Empirical theoretical account

A general regulation in association methodological analysis is to regress accounting informations with steps of stock public presentation. R2 measures the overall relation between the variables and the value relevancy of accounting informations is assessed based on the value of this index. The relevancy of each accounting figure included in the equations is acknowledged if their coefficients are statistically important.

The market based accounting research literature provides a series of empirical theoretical accounts for rating surveies that can be divided in two wide classs: theoretical accounts that usage monetary values as the step for stock public presentation and theoretical accounts that usage returns. Both present econometric issues that we must take into history when construing the consequences of the analysis. ( Filip & A ; Raffournier, 2010 ) Supply a thorough treatment related to this facet. Apparently monetary value theoretical accounts ‘produce better specified estimated earnings-response coefficients ‘ . This premise is based on Kothari and Zimmerman ( 1995 ) paper. The negative side of monetary value theoretical accounts as described in Brown et.al ( 1999 ) is determined by the scale consequence, taking to a reduced explanatory power or smaller R2.

On the other manus return arrested developments extinguish the graduated table consequence because the variables are standardized by the old period monetary value. However, if the monetary values lead net incomes or if the net incomes have ephemeral constituents[ 1 ]than the theoretical account tend to gauge the coefficient toward nothing.

Taking in consideration above mentioned issues I chose to use a theoretical account from each class.


Price theoretical account is derived from Ohlson ( Ohlson, 1995 ) rating theoretical account and unlike return theoretical account assumes that market value of a stock is determined by both its book value and the net incomes constituent.

Monetary values represent the twelvemonth terminal values and non the value in the month of net incomes proclamations. ( Dobija & A ; Klimczak, 2010 ) supply a good statement in favour of utilizing the twelvemonth terminal monetary values. They consider that this alternate ‘removes a possible prejudice caused by noise from value relevant events that occur after the fiscal twelvemonth terminal ‘ . Furthermore, the twelvemonth terminal monetary values incorporate new information related to events go oning in the undermentioned twelvemonth whereas net incomes incorporate merely past information. Another ground of utilizing yearend monetary values is the fact that net incomes information is already assimilated by the market to a great extent from the quarterly net incomes proclamations.

It is a derivation from a cardinal association survey because of the 2nd explanatory variable, ‘ alteration in net incomes ‘ used as a step for unexpected net incomes. Besides the first independent variable which is a step for the degree of net incomes, the 2nd independent variable will measure the investors ‘ reaction to fluctuations in companies ‘ public presentation.

This version of empirical theoretical account is peculiarly utile in this instance survey because it provides extra information about the belongingss of accounting informations such as seasonableness and conservativism[ 2 ]. Presumably, these features are less apparent in a code-law state. Harmonizing to ( Ball, Kothari, & A ; Robin, 2000 ) in codification jurisprudence states, such as Romania, there is a strong politicization of accounting, taking to a interest holder orientation in the corporate administration of the houses. This implies that ‘ the demand for accounting income is influenced more by the payout penchants of agents for labour, capital and authorities and less by the demand of public revelation ‘ . ( Ball, Kothari, & A ; Robin, 2000 ) Therefore, net incomes direction is more outstanding. IAS is advancing a crystalline attack of revelation similar to common jurisprudence states, fact that should restrict the net incomes direction chances. However acceptance of international criterions is non plenty if there are no control mechanisms to guarantee pertinence.

When deducing about the monetary value net incomes relation I take into consideration three major facets defined by three hypotheses. First I assess the overall earnings-price relation get downing with the premise that accounting information is less relevant in an emerging market. Statistical analysis implies running a pooled arrested development over the 5 old ages for all the companies available. The method is Ordinary Least Squares.

My 2nd aim is to measure the impact of late adopted IFRS by Romania on the value relevancy of accounting information. From 2005 to 2007 execution of IFRS was voluntary and the companies still had the chance to show the accounting information in a manner that would profit them, in other words net incomes direction was still possible. From 2007 the application of international criterions became compulsory. In this instance the premise would be that acceptance of IFRS would increase the value relevancy of accounting information. To reexamine this facet I will run a cross sectional arrested development for each of the five old ages and detect how R2 alterations over clip.

Last, I will detect the value relevancy of accounting for different companies, from a size position. The premise would be that accounting informations is more value relevant for smaller companies that for large 1s. Large companies are more liquid and have a lower grade of hazard and investors can obtain valuable information from varied beginnings whereas for smaller companies the chief beginning of information remains the fiscal statements. For this ground I will divide the companies in two subsamples harmonizing to the class they belong to. I will run the arrested development for both subsamples and compare the R2 ‘s obtained.

Descriptive statistics

Table 3 and 4 in Appendix A present descriptive statistics for monetary value and return theoretical accounts before taking outliers.

Monetary value has a average value of 8,1 for the entire sample. For the first class the average monetary value is 10,57 whereas for the 2nd class the average value is 7,27. One anomalousness related to monetary value values is that the maximal value in the 2nd class ( =508 ) is higher than the upper limit in the first class ( 272 ) which is supposed to hold bigger and more comfortable companies, therefore with a higher market value. Rough information besides present one instance of negative book value per portion in the first class. The monetary value fluctuation is changeless across sample. The book value per portion in the first class has a standard divergence of 54 which is much higher than in the other instances.

In the 2nd theoretical account variables besides present specific issues. If we compare the two classs it looks like the companies in the 2nd class were more profitable with a return average value of 23 comparing to 0,50 in the first class. In the same clip they were far more hazardous than their equals in the first class. SD has a tremendous value of 235 comparing to 1,81. When standardized by the last twelvemonth monetary value, net incomes per portion increase their average value to 2,45 and a standard divergence of 19.

Table 5: descriptive statistics: monetary value theoretical account

descriptive statistics: Price modelTables 5 and 6 summarize the consequences after extinguishing the outliers and Table 7 describes the information for the return theoretical account after extinguishing the negative earnings.Variable monetary value has a entire average value of 3,26 and a standard divergence of 7. Net incomes and book values have negative values as minimal figures. There are smaller net incomes in the 2nd category of companies, 0,1 comparing to 1,18 the mean value in the first category. In regard to book values the state of affairs is opposite, intending that category 1 companies have lower values than 2nd category companies.

Categ- represent the naming class in BSE

Total- represent the whole sample

Price – represent the stock monetary value

Eps- net incomes per portion

Bvs- book value per portion

The 2nd theoretical account follows the same forms as the first 1 with average returns and net incomes per portion higher in the first class. The alteration in net incomes per portion has a negative mean value for the companies in the first class significance that across clip these houses lost in value.

Table 6: descriptive statistics: return theoretical account

After taking the negative values in net incomes variable average value of eps increased to 0,18 for the overall sample. Changes in net incomes still have a negative value for the overall sample and for the companies in the first class.


Table 8 summarizes the chief findings from arrested development analysis. R2 measures the value relevancy of accounting information. It indicates the grade of variableness of a series that can be explained by the variableness of one or more series in a arrested development. For the monetary value theoretical account R2 is 40 % for the pooled arrested development bespeaking a high value relevancy of accounting in Romania. However, the coefficient of net incomes per portion is non statistically important, the chief forecaster for monetary values being the book value of equity. R2 from the return theoretical account has a really low value of merely 8 % bespeaking a little value relevancy of accounting informations.

After riddance of negative net incomes per portion the overall consequences have improved. R2 of the return theoretical account increased to 16 % . Elimination of negative net incomes is supported by the hypothesis that ephemeral net incomes lower the value relevancy of accounting information as described in ( Kothari, 2001 ) . Harmonizing to ( Hayn, 1995 ) the losingss are perceived by investors as being transitory. ‘Because stockholders have a settlement option, the informativeness of losingss with regard to future hard currency flows is limited ‘ . This attack was besides adopted by ( Hellestrom, 2006 ) .

In what concerns the premise of the value relevancy betterment over clip R2 fluctuation supports this hypothesis. In 2007 when IFRS became compulsory return theoretical account studies an addition of R2 to 36 % the highest value in all old ages and the monetary value theoretical account has an R2 of 70 % . 2008 registry a downswing of the R2 value for both theoretical accounts. This deficiency of relevancy should be judged in a broader context of macroeconomic factors that affected the investors perceptual experience in 2008. BSE was described by a general province of extreme volatility induced by international fiscal crisis, volatility that negatively affected the capitalisation and the liquidness of the market. In 2009 R2 registered additions for both theoretical accounts.

The value relevancy of accounting information is perceived in a distinguishable manner by the two sections of the market. Contrary to the hypothesis and to general theory that accounting is more value relevant for smaller companies the consequences show a higher R2 for the companies in the first class. A possible account for this state of affairs could be the fact that the companies in the 2nd class outperformed the others in 5 old ages out of 6. The average return is well higher in 2005-2007 and the loss in 2008 is smaller as reported in table ten in appendix A. As a decision the investors focused more on these cheaper yet profitable companies.

In the monetary value theoretical account net incomes per portion coefficients are statistically important in 2006 and 2007 whereas the book value per portion coefficients reveal the prognostic power of this variable in measuring the market value for the whole period.

In the instance of return theoretical account net incomes per portion are statistically important for the pooled information every bit good as for the first 2 old ages. One perplexing consequence is the negative coefficient for the variable difference in net incomes. Although it does non hold statistical significance the negative coefficient could be interpreted as the investors do non take into history the net incomes alterations when doing investing determinations. Several accounts were given by writers analyzing value relevancy of accounting in emerging economic systems. For case, ( Hellestrom, 2006 ) considers that this negative coefficient is due to the being of ephemeral net incomes, the market expecting a contrary state of affairs for the undermentioned period. ( Filip & A ; Raffournier, 2010 ) assume that this is a consequence of the market inefficiency, the returns reflecting more of the old twelvemonth net incomes than for the current twelvemonth. The consequences are shown in table 10.

For the revised return model the net incomes coefficient is statistically important for the pooled arrested development every bit good as for every twelvemonth. The alteration in net incomes coefficients did non alter much. Contrasting the monetary value theoretical account eps coefficients are statistically important for both sections of the market, intending that net incomes are value relevant for the alterations in market values. The consequence are shown in table 11.

Table10 variable coeffcients for return theoretical account

Tables 10 and 11 present the coefficients values, t trial and P values for pooled arrested development, for every twelvemonth cross-sectional arrested developments every bit good as the pooled arrested developments for each class of listed companies individually

Decision and restrictions

The value relevancy of accounting information in passage economic systems has proven to be of great involvement for regulators when measuring the execution of new accounting regulations every bit good as for foreign investors when diversifying their international portfolios.

In this instance R2 varies strongly across clip from 15 % to 36 % in return theoretical account and from 17 % to 80 % in the monetary value theoretical account. The arrested development based on returns provides consequences which are consistent with other European surveies as reported in ( Dumontier & A ; Raffournier, 2002 ) . In the first old ages of IFRS acceptance the value relevancy of accounting was higher. One cause of these consequences may be the fact that IFRS based revelations supply a much relevant accounting informations for investors than local GAAP. In the same clip the alternate beginnings of information were fewer than in recent old ages. Variations can besides be explained by fluctuations in economic conditions and alterations in regulative background.

One interesting consequence shows that accounting information is more value relevant in first class than in the 2nd class of the market. This consequence contradicts the general belief that for the smaller companies the relation between stock and accounting informations should be more powerful because the alternate beginnings and fiscal analysts focus on the first category companies and the lone beginning of information for the latter 1s would be their fiscal studies.

One restriction of the survey is the fact that it is based on the premise of market efficiency. Yet no formal trials are conducted. ( Harrison & A ; Paton, 2004 ) tested market efficiency before 2000 and reached the decision of a weak signifier efficiency. Today there are plentifulness of grounds to believe in a semi strong efficient market. Besides. the consequences are sensitive to the nature of informations and to the theoretical accounts employed. There are differences in R2 between the theoretical accounts before and after exclusion of outliers and negative net incomes, severally.

The monetary value theoretical account used is universally accepted and used by many writers. The motive behind it is that the consequences are comparable with other association surveies. The return theoretical account presents some enigmatic consequences for alteration in gaining variable, which suggests the necessity for a farther research in the quality of accounting informations. Although IFRS were adopted by Romania the execution procedure was a hard 1 with a low grade of conformity. The major obstructions stated by Albu et Al, ( 2011 ) are the dominant place of the province and the financial policy, the decreased power of internal coercive factors and a decreased importance of accounting profession. Ths survey can be considered a first measure in the analysis of the accounting value relevancy in an rising state. For an enhanced image of the impact of accounting information on the investors determinations in one state a more specific theoretical account that takes into history national features would be more suitable. This type of theoretical account would besides better measure the influences of IFRS ordinance for a specific state.