The Value Relevance of Accounting Information: Testing the

School: Northeastern University - Course: SCHM 6318 - Subject: Accounting

hapter 5 The Value Relevance of Accounting InformationMBA AF 691-Financial Accounting Theory and Analysis SPRING 2023 5 - 2 Ch. 5 is about...... (Summary) •Assumes securities market efficiency •Investors are responsible for predicting future firm performance -The role of financial reporting is to provide useful information for this purpose •The usefulness of financial statement information is evaluated by magnitude of security price response to that information -We discuss empirical evidence in Chapter 5. -Helps accountants to evaluate decision usefulness of different accounting information 5 - 3Why do stock prices move? •Reasons for market response to accounting information -An application of decisiontheorymodel (Ch. 3) •Investors have prior probabilities of future firm performance •Investors obtain useful information from financial statements •Investors revise their probabilities •Leads to buy/sell decisions •Security price and share return change -If the new accounting information is not useful, then stock price should not change (efficient market hypothesis; Ch. 4) 5 - 4 Testing the usefulness of accounting information •We will discusshow to testthe usefulness of accounting information •We will then discuss some empirical studies suggesting evidence on the usefulness of accounting information •The usefulness of accounting information, -If there is new accounting information and stock price moves, then "accounting information is useful" •For the stock price change, we meanunexpected stock price •For the new accounting information, we mean unexpectedaccounting news 12 34

5 - 5Abnormal (unexpected) share return•Abnormal share return -Research examines the effect of earnings informationon returnon firms' common shares -Totalshare return =expectedreturn due tomarket-wide factors ±unexpected(abnormal) return due tofirm-specific factor Recall from Chapter 4 (CAPM): E(Rj)= Rf+ βj(E(RM) - Rf ) = Rf(1 -βj) + βjE(RM ) =α+ βjE(RM )[This is an 'expected' model] →Rj=α+ βj(RM)+εj [This is an 'actual' model] 5 - 6 •Abnormal share return -Expected share return (α+βj(RM )) can be attributed to market-level information -Abnormal share return (εj ) can be attributed to accounting information -If good news in financial statements leads to positive abnormal share returns (and vice versa), we conclude financial statement information is useful. -To reach such a conclusion, we need to separate market-wide and firm-specific share return