ACCT 403: Accounting Research and practices

International Journal of Scientific and Research Publications, Volume 4, Issue 10, October 2014 1 ISSN 2250-3153

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Value Relevance of Accounting Information: An

Empirical Study of Selected Indian Firms

Manisha Khanna

Research Scholar, Department of Business Management and Commerce, University Business School, Panjab University, Chandigarh, and Assistant

Professor, Department of Commerce at Govt. PG College, Kalka

Abstract- The present study analyses the combined, individual, and incremental value relevance of accounting information

produced by firms listed on the S&P BSE-500 for FY-2006 to

FY-2010, and changes therein over a period of time. Results

provide sufficient evidence that accounting information is value

relevant for BSE-listed firms. The combined value relevance of

accounting information represented by earnings per share and

book value per share has declined while there have been

insignificant changes in the incremental value relevance of

accounting information.

Index Terms- Value relevance, earnings per share, book value of equity per share.

I. INTRODUCTION

alue relevance research is motivated by the fact that listed

firms use financial statements as one of the major medium

of communication with their shareholders and public at large.

Market usually depends on financial reports prepared by the

management of such firms. For making the financial reporting to

be effective, information contained in the financial reports should

be relevant and reliable (Barth et al., 2001). Information is

considered to be relevant when it influences the users’ decisions

to form predictions or help in confirming or correcting the past

evaluations, while, it is considered reliable if can be depended

upon to faithfully represent the transactions or events that it aims

to represent without any undue error or bias (FASB, 1976).

According to Barth et al. (2001) a value relevant information

should have both the features of relevance and reliability.

The value of a firm is based on what the market perceives

about its performance, and accounting disclosures provide the

essential information so as to form the basis of such perception.

Many studies have examined the value relevance of earnings per

share (EPS), book value of equity per share (BVPS), and cash

flows. Such studies have reported that earnings and book values

have significant information content for equity valuation of a

firm (e.g., Dechow, 1994; Cheng et al., 1996; Pfeiffer et al.,

1998; Holthousen and Watts, 2001; Choi et al., 2006; Kwon,

2009). Earnings and book values are considered more value

relevant for firm’s valuation than cash flows, as cash flows

usually have severe matching and timing problems (Ohlson,

1995; Barth et al., 1998; Collins et al., 1999). Studies have also

suggested that the value relevance of earnings and book values

move inversely to one another, and that decline in value

relevance of earnings is accompanied by increase in value

relevance of book values (Berger et al., 1996; Burgstahler and

Dichev, 1997; Collins et al., 1997).

Research on value relevance of accounting information has

lately drawn attention of both practitioners and academicians,

specifically, during the global financial crisis of 2007-2009

reported by North America and European banks. Further, the

recent scandals in India, such as the fraud at Satyam, have also

highlighted the value relevance of accounting information for the

Indian capital market (Krishnan and Krishnan, 2013). However,

in India, the researchers have mainly focused on value relevance

of financial statements with main focus on cash flow reporting

(Vishnani and Shah, 2008; Srinivasan and Narsimhan, 2010).

II. LITERATURE REVIEW

This part of literature review has focused on studies that

have examined the value relevance of accounting information.

An accounting figure is value relevant if it has a significant

strong predicted association with the stock prices or stock market

indicators such as price-to-earnings or price-to-book ratios (Amir

et al., 1993). A large part of literature has identified earnings per

share (EPS) and book value per share (BVPS) as the two most

important accounting measures that have a significant positive

association with market value of a firm, proxy by share prices

(e.g., El-Gazzar et al., 2006; Clarkson et al., 2009; Oyerinde,

2009; Alfaraih and Alanezi, 2011; Khanagha et al., 2011). Hunt

et al. (1997) reported that the incremental explanatory power of

BVPS has been found to be higher than that of EPS. The

explanatory power of earnings and book value for stock prices in

China had increased over time through 1992 to 1996 (Bao and

Chow, 1999). Using a return and price model, Chen et al. (2001)

examined the relationship between accounting information

represented by EPS and BVPS, and stock price in the Chinese

stock market during 1991-1998. Their findings showed that

accounting information was value relevant according to both

pooled cross-section and time-series regression.

Safajou et al. (2005) examined the empirical relationship of

EPS and BVPS with stock market value, using the Ohlson (1995)

model for the period 1997-2003. The results showed that there

was a significant relationship between EPS, BVPS and price.

Ragab and Omran (2006) investigated the value relevance of

earnings and book values in the Egyptian market from 1998-

2002 and explored that, based on both returns and price models,

EPS and BVPS were all relevant and explained about 40 percent

of the variation in stock prices. Qystein and Frode (2007)

evaluated the value relevance of financial reporting over a period

of 40 years highlighting that the value relevance of Norwegian

V

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GAAP was non-declining throughout 1965-2004. Chandra and

Ro (2008) found that the combined value relevance of earnings

and revenues had stayed constant and that the value relevance of

earnings had declined while the impact of revenues on price had

not decreased. Pourheydari et al. (2008) compared the value

relevance of book value and dividends versus book value and

reported earnings in the Tehran Stock Exchange from 1996-

2004. The results indicated that there was a positive relationship

of dividends, book value, and earnings with stock market value.

Dung (2010) tested the value relevance of financial statement

information on the Vietnamese stock market. Results showed

that the value relevance of accounting information was

statistically meaningful, though somewhat weaker than in other

developed and emerging markets. Filip (2010) investigated the

impact of the mandatory IFRS adoption in Romania to show an

increase in the value relevance of earnings post IFRS

implementation.

Some studies have examined the value relevance of earnings

and book values for voluntary early adopters of the International

Accounting Standards (IASs). Bartov et al. (2005) examined the

effect of adoption of IASs for their sample of 37 German

companies using a linear pricing model. They employed a pre-

post design and found an increase in the value relevance of

earnings on switching from the German GAAP to IASs. Hung

and Subramanyam (2007) explored the value relevance of re-

statement differences for 80 voluntary (early) IASs adopters in

Germany. They found that the combined value relevance of EPS

and BVPS decreased after switch to the IASs. Barth et al. (2008),

used a pre-post design for a sample of 319 firms that voluntarily

adopted IASs between 1994-2003, found that the R 2 for the price

level model increased from 28 percent to 40 percent in the

adoption year relative to the pre-adoption year for the IASs

adopters.

III. OBJECTIVES OF THE STUDY

- To determine the value relevance of accounting

information represented by earnings and book values,

- To examine the changes in the value relevance of

accounting information over a period of time.

IV. RESEARCH METHODOLOGY

The S&P BSE-500 Index constitutes the population for the

present analysis. The study has been carried out for the financial

years April 01, 2006 to March 31, 2011. Companies in the

banking, insurance, finance industry, and central public sector

enterprises (CPSEs) were eliminated due to their unique industry

regulations. Finally, companies with missing data over the study

period and financial year ending other than the fiscal year (April

01 - March 31) of a particular year were excluded from the

analysis. These sample selection criteria resulted in a final

sample of 241 firms with 1,205 firm-year observations over the

five year study period for assessing the value relevance of

accounting information.

The data required for the study relates to the stock price and

financial reporting information, which has been obtained from

the corporate database (PROWESS) maintained by the Center for

Monitoring the Indian Economy (CMIE), annual reports of the

companies, and the website of the BSE

(http://www.bseindia.com), and Moneycontrol

(http://www.moneycontrol.com). In order to examine the value

relevance of accounting information, the measurement approach

of value relevance has been used. According to this approach,

value relevance of financial statements is measured by their

ability to capture or summarize the information that has affected

stock price summaries which makes them relevant in equity

valuation. The Ohlson (1995) Price Valuation Model has been

used in the present study to determine the value relevance of

accounting information. This model expresses market price per

share (MP) as a function of both earnings per share (EPS) and

book value per share (BVPS). The following Value Relevance

Models have been used to assess the value relevance of

accounting information:

Model 1: MPjt = α0 + α1 EPSjt + α2 BVPSjt + ejt

Model 2: MPjt = β0 + β1 EPSjt + ejt

Model 3: MPjt = γ0 + γ1 BVPSjt + ejt

where

MPjt = Market price per share of firm j in year t three months

after the balance sheet date

EPSjt = Earnings per share based on PAT for firm j in year t

BVPSjt = Book value of equity per share for firm j in year t

ejt = Error term for firm j in year t

V. RESEARCH HYPOTHESES

Based on literature review, following research hypotheses

have been formulated regarding value relevance of accounting

information:

H1a: There is a positive relationship between market value

of a firm represented by share prices and accounting

information represented by EPS and BVPS.

H1b: The incremental and combined value relevance of

accounting information changes over a period of time.

VI. ANALYSIS AND RESULTS

6.1 Descriptive Statistics

Descriptive statistics were generated for the sample used to

test value relevance hypotheses. Table 1 provides descriptive

statistics based on the panel cross-sectional times series using the

full sample of 1,205 firm-year observations for the dependent

and independent variables. The table shows the mean, median,

standard deviation, minimum, and maximum for the variables of

interest.

Table 1: Descriptive Statistics (n = 1,205)

Variable Mean Median Standard

Deviation

Minimum Maximum

MP 41.051 21.067 57.402 0.706 583.058

EPS 2.567 1.468 4.030 -5.416 76.806

BVPS 13.305 9.025 13.028 0.106 93.121

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Note: MP is the market price per share of firm j in

year t three months after the balance sheet date. EPS is the

earnings per share based on PAT for firm j in year t.

BVPS is the book value of equity per share for companfirmy j in

year t.

Table 1 shows that MP varied significantly, ranging from ₹

0.706 crore to ₹ 583.058 crore with a mean (median) of ₹ 41.051

crore (₹ 21.067 crore). The table indicates that the mean

(median) EPS during the study period is ₹ 2.567 (₹ 1.468 crore),

ranging from a loss of ₹ 5.416 crore to ₹ 76.806 crore. The mean

(median) BVPS is ₹ 13.305 crore (₹ 9.025 crore), ranging from ₹

0.106 crore to ₹ 93.121 crore. Mean BVPS is about five times higher than that of EPS. The mean values of MP, EPS, BVPS,

tended to be higher than their respective median, indicating that

the distribution was positively skewed.

6.2 Correlation Analysis

The correlation is examined to measure the association

between the variables. Table 2 shows the Spearman correlation

coefficients (above the diagonal) and the Pearson correlation

coefficients (below the diagonal) for the panel data.

Table 2: Correlation Matrix (n = 1,205)

Variable MP EPS BVPS

MP 1.000 0.800 **

0.612 **

EPS 0.652 **

1.000 0.765 **

BVPS 0.602 **

0.689 **

1.000

Note: ** Correlation is significant at the 0.01 level (two-tailed). * Correlation is significant at the 0.05 level (two-tailed). MP

is the market price per share of firm j in year t three months after the balance sheet date. EPS is the earnings per share based on PAT

for firm j in year t. BVPS is the book value of equity per share for firm j in year t.

The correlation matrix shows, in line with expectations, a

strong positive correlation between EPS and MP (0.800). The

association between BVPS and MP is also strong and positive

(0.612) but less in magnitude than that of EPS with MP. Similar

results are obtained for the Pearson correlation. EPS and BVPS

are also significantly positively correlated with each other.

6.3 Multivariate Analysis

6.3.1 Value Relevance of Accounting Information

The objectives of the study are to determine the value

relevance of accounting information represented by EPS and

BVPS, and changes therein over a period of time. Panel and

yearly cross-sectional regressions of value relevance models are

determined for this purpose. Yearly cross-sectional regressions

help in examining the changes in the combined and incremental

value relevance of EPS and BVPS. Adjusted R 2 is used as the

primary indicator of the value relevance of accounting

information. Further, the significant regression coefficients of the

independent variables are used as an indicator of value relevance

of individual independent variables.

Consistent with past research, Adjusted R 2 T obtained from

Model 1 yields the result of combined value relevance of

accounting information while the Models 2 and 3 have been

inserted so as to determine the individual value relevance of EPS

and BVPS, as measured by their respective Adjusted R 2 s

(Collins et al., 1997). The Adjusted R 2 T (combined value

relevance of accounting information) has been decomposed into

two parts, viz., incremental explanatory power provided by EPS

represented by Adjusted R 2

EPS, and incremental explanatory

power provided by BVPS represented by Adjusted R 2

BVPS. Table

3 presents the results of Generalised Least Square Random Effect

Model for the panel and yearly cross-section regressions of MP

on EPS and BVPS jointly, individually, and incremental value

relevance of EPS and BVPS.

Table 3: Panel and Yearly Cross-sectional Regressions of MP on EPS and BVPS

Model 1: MPjt = α0 + α1 EPSjt + α2 BVPSjt + ejt Model 2: MPjt = β0 + β1 EPSjt + ejt Model 3: MPjt = γ0 + γ1 BVPSjt + ejt Year N α1 α 2 Adj.

R 2

T

(A)

F

Statistics

(p-value)

β1 Adj.

R 2 2

(B)

γ1 Adj.

R 2 3

(C)

Adj.

R 2 EPS

(A)

–

(C)

Adj.

R 2 BVPS

(A)

–

(B)

2006-2007 241 13.615 ***

(4.83)

1.126 *

(1.92)

0.611 56.06

(0.000)

16.384 ***

(8.57)

0.603 4.606 ***

(9.59)

0.458 0.153 0.008

2007-2008 241 5.240 ***

(4.82)

1.392 ***

(3.53)

0.593 60.13

(0.000)

8.466 ***

(9.30)

0.556 2.932 ***

(10.95)

0.526 0.067 0.037

2008-2009 241 12.409 ***

(7.35)

0.634 **

(2.47)

0.614 61.27

(0.000)

14.022 ***

(9.78)

0.604 2.652 ***

(9.65)

0.336 0.278 0.010

2009-2010 241 10.206 ***

0.540 *

0.532 37.91 12.256 ***

0.526 2.368 ***

0.416 0.116 0.006

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(4.48) (1.28) (0.000) (8.56) (9.21)

2010-2011 241 2.287 ***

(1.43)

1.520 ***

(4.65)

0.383 29.31

(0.000)

4.621 **

(2.09)

0.248 1.997 ***

(7.91)

0.341 0.042 0.135

Panel 1,205 5.855 **

(2.31)

1.124 **

(2.60)

0.470 7.768 ***

(3.26)

0.426 2.426 ***

(10.03)

0.362 0.108 0.044

Wald χ 2

123.09

(0.000)

10.65

(0.000)

100.60

(0.000)

Note: *, **, *** Significant at 10%, 5%, and 1% (two-tailed) respectively. All regressions are performed with robust standard

errors. t - statistics based on robust standard errors are reported in parentheses. MP is the market price per share of firm j in

year t three months after the balance sheet date. EPS is the earnings per share based on PAT for firm j in year t. BVPS is the

book value of equity per share for firm j in year t.

As evident, coefficients on EPS and BVPS are positive and

significant at better than the 5 percent level in every year and 1

percent level in most of the years. In general, as the estimated

coefficient for EPS declines from one year to the next, the

estimated coefficient for BVPS increases, and vice-versa. As can

be observed, EPS response coefficient declines from 13.615 to

5.240 in 2007-2008 and BVPS estimated coefficient increases

from 1.126 to 1.392. Similarly, decline in EPS estimated

coefficient from 10.206 to 2.287 in 2010-2011 is set-off by

increase in BVPS estimated coefficient from 0.540 to 1.520. The

Adjusted R 2 of the yearly cross-sectional regressions of MP on

EPS and BVPS ranged from 0.383 in 2010-2011 to 0.614 in

2008-2009. The Adjusted R 2 of the yearly cross-sectional

regressions of MP on EPS ranged from 0.248 in 2010-2011 to

0.604 in 2008-2009 while yearly cross-sectional regressions of

MP on BVPS ranged from 0.336 in 2008-2009 to 0.526 in 2007-

2008.

The Adjusted R 2 for the panel cross-sectional time series

regression indicates that EPS and BVPS jointly explain about

0.470 of the cross-sectional variation in share prices. Overall, the

results are significant for the regression coefficient as well as for

the regression model (Wald χ 2

= 123.09; p < 0.01). The

coefficient estimates of EPS (β = 5.855; p < 0.05) and BVPS (β

= 1.124; p < 0.01) are significantly positive and consistent with

past research (Collins et al., 1997; Ou and Sepe, 2002), thus,

confirming the value relevance of EPS and BVPS for firms in

the sample. The significantly positive coefficient estimates for

the panel and yearly cross-sectional regressions support the

conjecture that both EPS and BVPS are significantly positively

related to share prices. It indicates that a one unit increase in EPS

is expected to generate 5.855 times unit increase in MP, while a

unit increase in BVPS is expected to generate a MP increase of

1.124 units per share.

Results of panel data of Value Relevance Model 2 shows

that EPS individually explains about 0.426 of the variation in

MP (Wald χ 2

= 10.65; p < 0.01). The coefficient on EPS (β =

7.768; p < 0.01) is positive and significant at 1 percent level.

Results of panel data of Value Relevance Model 3 reveal that

BVPS individually explains about 0.362 of the variation in MP.

The coefficient on BVPS (β = 2.426; p < 0.01) is also positive

and significant at 1 percent level (Wald χ 2

= 100.60; p < 0.01). It

is also evident that the incremental value relevance of EPS

(Adjusted R 2

EPS) is about 2.454 times more in magnitude than the

incremental value relevance of BVPS (Adjusted R 2

BVPS), i.e.,

0.108 vs. 0.044. This is visible in results of yearly cross-sectional

regressions also. The incremental explanatory power of EPS

increases and decreases over time but it always remains greater

than the incremental explanatory power of BVPS except for the

year 2010-2011. In all the years under analysis, magnitude of

coefficient on EPS is more than the coefficient on BVPS.

Further, the value for Adjusted R 2 s obtained from Value

Relevance Model 2 is more than that of Model 3 except for the

year 2010-2011. Overall, these results confirm the findings of

Oyerinde (2009) that EPS is the single accounting number that is

reported most often in media and receives the most attention of

investors.

Thus, the findings based on the price model strongly support

H1a that there is a positive relationship between market value

of a firm represented by share prices and accounting

information represented by EPS and BVPS. The results for the

Value Relevance Model 1 are also consistent with the findings

obtained from the developed markets (Collins et al., 1997;

Francis and Schipper, 1999; Hellstrom, 2006). For e.g., in the

present study, EPS and BVPS jointly explained 0.470 of the

cross-sectional variation in MP, which in the Collins et al.

(1997), a benchmark in the value relevance literature, was 0.540.

The yearly cross-sectional regressions of MP on EPS and BVPS

in the present study ranges from 0.383 to 0.614, which is also

consistent with the findings of Collins et al. (1997), which

obtained 0.502 percent to 0.754. These results suggest that BSE-

listed companies have earnings and book values that generally

display properties similar to those in developed markets.

In addition, when comparing the results of present study

with those of previous studies in emerging markets, the EPS and

BVPS of BSE-listed companies appear more value relevant. For

e.g., Ragab and Omran (2006) revealed that earnings and book

values explained about 0.400 of the variations in stock prices

during 1998-2002 in the Egyptian equity market, being 0.07

lower than results of present study. Similarly, Bae and Jeong

(2007) investigated the value relevance of earnings and book

values of the Korean firms during 1987-1998. Their results

showed that earnings and book values explained 0.340 of the

variations in security prices, which was 0.130 lower than for

BSE-listed companies. Results of this study are also comparable

with prior value relevance studies in India, which provide

support for the value relevance of dividend, and return on net

worth.

In summary, the findings for the price regressions provide

convincing evidence that the EPS and BVPS for the sample of

BSE-listed firms reported played an important role in equity

valuation for the period 2006-2010. The results confirm with

those found in mature capital markets. Interestingly, the results

International Journal of Scientific and Research Publications, Volume 4, Issue 10, October 2014 5

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show that EPS and BVPS are more value relevant in India than

other emerging markets. The results presented here are also more

significant than those found by earlier Indian-based studies on

value relevance.

6.3.2 Changes in the Combined and Incremental Value

Relevance of Accounting Information

Studies based on the investigation of changes in the value

relevance of earnings and book values have found that the

incremental value relevance of EPS has declined over a period of

time, but it has been offset by an increased incremental value

relevance of BVPS. Thus, overall the combined value relevance

of these two accounting measures has not declined (Collins et al.,

1997; Francis and Schipper, 1999; Lev and Zarowin, 1999, Jang

et al., 2002). In this section, it is determined whether there are

any significant differences across time in the combined or in the

relative incremental value relevance of EPS and BVPS. The

Adjusted R 2 T obtained from Value Relevance Model 1 and

incremental value relevance of EPS (Adjusted R 2 EPS) and BVPS

(Adjusted R 2 BVPS) were regressed on a time-trend variable

(TIME). The significant regression coefficient of explanatory

variable (TIME) has been used as an indicator of change in the

combined and incremental value relevance of EPS and BVPS.

The value relevance is expected to have declined (increased)

over a period of time if the regression coefficient on TIME turn

out to be significantly negative (positive). Table 4 presents the

results of regressing combined, and incremental EPS and BVPS

on TIME-trend variable.

Table 4: Regression of the Adjusted R 2

T, Adjusted R 2

EPS and Adjusted R 2 BVPS on a Time-trend Variable

Adj.R 2

T = δ0 + δ1 TIME + ejt (i)

Adj.R 2

EPS = θ0 + θ1 TIME + ejt (ii)

Adj.R 2

BVPS = λ0 + λ1 TIME + ejt (iii)

δ0 δ1 Adj. R 2

θ0 θ1 Adj. R 2

λ0 λ1 Adj. R 2

0.702 ***

(12.97)

-0.052 *

(-2.70)

0.707 0.183 *

(2.55)

-0.017

(-0.97)

0.087 -0.028

(-0.81)

0.022

(1.43)

0.411

Note: *, **, *** Significant at 10%, 5%, and 1% (two-tailed) respectively. All regressions are performed with robust standard

errors. t-statistics based on robust standard errors are reported in parentheses.

The results from regressing the Adjusted R 2 values of

combined and incremental EPS and BVPS on a time-trend

variable demonstrate that there is a significant decline in the

combined R 2 value over the sample period (δ1 = - 0.052, p <

0.10). However, the coefficients on the TIME variable for

incremental EPS and incremental BVPS suggest that there is an

insignificant decline in the incremental value relevance of EPS

(θ1 = -0.017) and an insignificant increase in the incremental

value relevance of BVPS (λ1 = 0.022) over the sample period.

These results are not in conformity with prior research which has

demonstrated a significant decline in the incremental value

relevance of earnings, but has been offset by the increased

incremental value relevance of book values (Collins et al., 1997;

Francis and Schipper, 1999; Lev and Zarowin, 1999, Jang et al.,

2002). Thus, these results do not hold H1b, i.e., the incremental

and combined value relevance of accounting information

changes over a period of time.

VII. CONCLUSION

Consistent with expectations, the findings based on the price

regressions provide evidence of the value relevance of EPS and

BVPS for a sample of 1,205 firm-year observations for FY 2006

to FY 2010 BSE-listed firms. The results for the combined price

regression are also consistent with the findings obtained from the

developed markets. In addition, when comparing the results of

present study with those of previous studies in emerging markets,

as well India, the EPS and BVPS of BSE-listed firms appear to

be more value relevant. There has been a significant decline in

the combined value relevance of accounting information over the

sample period. MP is the primary dependent variable while EPS

and BVPS are the two key independent accounting measures

used in the study. The study could be extended by including

more independent variables like cash flows, dividends, etc., for

examining variation in share prices or by conducting pooled

analysis.

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AUTHORS

First Author – Manisha Khanna, Research Scholar, Department

of Business Management and Commerce, University Business

School, Panjab University, Chandigarh, and Assistant Professor,

Department of Commerce at Govt. PG College, Kalka. E-mail:

[email protected]