COMM 318 Chapter Notes - Chapter 5: Financial Statement, Cash Flow, Risk Measure

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9 Feb 2016
Chapter 5: The Value Relevance of
Accounting Information
5.1 Overview
Value Relevance: when accounting information prompts a response through the change of
securities prices
Ball and Brown conducted first study on this in 1968, with the broad conclusion that accounting
info is generally useful to investors in helping them to estimate expected value and risk of
security returns
Value relevance approach assumes investors want to make their own predictions
oImplies accounting info is useful, helps them make decisions
Individual investors don’t pay for info (accounting statements) cost is swallowed by society since
prices are raised in order to cover these costs
oNot necessarily beneficial to society since not everyone is an investor and would find the
info useful
5.2 Outline of the Research Problem
5.2.1 Reasons for Market Response
*F/S information (in this chapter) = NET INCOME
Investors will react different to info, if more investors think the info is good news than those who
think it’s bad news, then the stock price will go up and vice versa
5.2.2 Finding the Market Response
There’s a narrow window of a few days for the market to react to new information – in studies
net income was examine the day of info release
Good/bad news determined relative to what investors expected, so studies obtained a proxy for
what expected NI would be based on previous earnings and analyst forecasts
In the study they tried to separate reactions to new NI information from all other new information
(like government regulation, economic conditions, etc.)
5.3 The Ball and Brown Study
5.3.1 Methodology and Findings
First to prove that accounting information and financial statements have value relevance
Event Study: the type of research used, studies the narrow window securities market reaction
to a specific even (release of NI)
5.3.3 Outcomes of the BB Study
Opened a additional usefulness issues – magnitude
oDoes the magnitude of expected earnings relate to the magnitude of the security market
Found that the greater the change in unexpected earnings, the greater the security market
response (consistent with CAPM and decision usefulness)
Main question: for a given amount of unexpected earnings, is the security market response
greater for some firms than for others?
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