On the Importance of Accounting Information for Stock Market Efficiency
|Author(s):|| Jiří Novák M.Sc., Ph.D., Deloitte Corporate Chair, |
|ISSN / ISBN:||1103-8454|
|Published in:||Universitetstryckeriet, Uppsala University|
|Publishing place:||Uppsala, Sweden|
|Keywords:||accounting, capital markets, efficiency, momentum, liquidity, accounting conservatism, transitory earnings, IFRS, Sweden|
|JEL codes:||M41, G12, G14, G15|
|Abstract:||This thesis contributes to the discussion on the importance of accounting information for stock market efficiency. As any analysis of market efficiency depends on the use of adequate risk proxies, the thesis first investigates the ability of commonly used risk factors to explain the cross-sectional variation of Swedish stock returns. The findings suggest that capturing risk is indeed very complicated, as neither CAPM beta nor size and book-to-market equity ratio are significantly associated with realized monthly returns. The relative bid-ask spread is found to be the strongest of all the analyzed factors; nevertheless it does not seem to be related to momentum in the manner predicted in the conceptual argument presented earlier in the paper.
Second, the thesis documents that simple accounting summary measures, such as earnings and book value of equity, can be used as benchmarks for the identification of mispriced stocks. Contrarian investment strategies (CISs) based on these simple measures earn a substantial value premium of 11-14%. In addition, we find that their effectiveness is compromised by noise that is caused by transitory earnings and accounting conservatism. Controlling for these factors increases the magnitude of the value premium and improves the consistency of the CIS. This suggests that the information reflected in key accounting measures is not fully reflected in stock prices.
Finally, this thesis shows that the structure of accounting information matters too. It documents that the transition from the Swedish GAAP to IFRS in 2005 not only changed the average goodwill charges reported by companies, but also affected valuation of goodwill-intensive companies. This suggests that investors were not able to see through the conservative treatment of goodwill prior to the adoption of IFRS and that they recognized its higher persistence only after being provided with accounting information directly highlighting it.
It is sometimes suggested that the structure of financial reporting “per se” should not be relevant to the valuation of companies, because the presentation itself does not the affect expected operating performance and because investors and analysts can “see through” and properly discount for various reporting formats. This thesis concludes that, contrary to this proposition, the structure of accounting does matter for equity valuation and that changes in representation do impact on stock prices.