Accounting Fundamentals and Variations of Stock Price: Forward Looking Information Inducement

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1 Accouning Fundamenals and Variaions of Sock Price: Forward Looking Informaion Inducemen Sumiyana Gadjah Mada Universiy Absrac This sudy invesigaes a permanen issue abou low associaion beween accouning fundamenals and variaions of sock prices. I induces no only hisorical accouning fundamenals, bu also forward looking informaion. Invesors consider forward looking informaion ha enables hem o predic poenial fuure cash flow, increase predicive power, lessen mispricing error, increase informaion conen and drives fuure price equilibrium. The accouning fundamenals are earnings yield, book value, profiabiliy, growh opporuniies and discoun rae or hey could be called as five-relaed-cash flow facors. The forward looking informaion are expeced earnings and expeced growh opporuniies. This sudy suggess ha model inducing forward looking informaion could improve associaion degree beween accouning fundamenals and he movemens of sock prices. In oher words, hey have higher value relevance han no by inducing. Finally, his sudy concludes ha inducing forward looking informaion could predic sock price accuraely and reduce sock price deviaions from heir fundamenal value. I also implies ha rading sraegies should realize o firm s fuure raional expecaions. Keywords: earnings yield, book value, profiabiliy, growh opporuniies, discoun rae, accouning fundamenals, forward looking, value relevance JEL Classificaion: M4 (accouning); G2 (asses pricing; ineres rae); G4 (informaion and marke efficiency); G5 (inernaional financial markes) Fakulas Ekonomi Universias Syiah Kuala

2 . Inroducion Permanen issue in accouning is he relaionship beween accouning informaion and sock price movemens. I is riggered by he objecives of financial reporing (FASB, 978) saed ha financial reporing mus presens informaion for boh invesors and poenial invesors o esimae fuure cash flow. Consequenly, i requires close associaion beween fundamenal firm value and is changes wih sock price variaions. The objecive of his sudy is o evaluae his associaion by designing new beer model, especially o esimae he value relevance of firms fundamenal value. Chen and Zhang (2007) presen heory and empirical evidences ha sock reurn is a funcion of accouning fundamenals. They indicae ha firm equiy value conains fuure poenial earnings and growh opporuniies. Lev (989), Lo and Lys (2000), and Kohari (200) have sudied he associaion beween sock reurn and fundamenal accouning informaion and found ha i is conradicory. They denoe ha he inconsisen associaion due o () weak relaionship beween earnings and sock price variaions, represened by adj-r 2 less han 0% (Chen and Zhang, 2007), and (2) lineariy relaionship beween accouning informaion and fuure cash flow, wih scalabiliy of equiy capial invesmen (Ohlson, 995, Felham and Ohlson, 995, 996, Zhang, 2000, and Chen and Zhang, 2007). This sudy focuses on designing new reurn model by inducing forward looking informaion o improve associaion degree beween accouning fundamenals and sock price variaions. Zhang (2000) and Chen and Zhang (2007) models include hisorical accouning daa or backward looking perspecive. Based on ha model, his sudy induces expeced fuure earnings yield and growh opporuniies or has forward looking informaion. I has some advanages. They are able o achieve value opimizaion (Shaw, 2007), give superioriy o fuure informaion (Lee and Yan, 2003), improve model accuracy (Chen, Yee, and Yoo, 2004), reduce fuure uncerainy (Giannnoni, 2008), and reduce sock price flucuaion (Brock, Dindo, and Hommes, 2006). This sudy is differen from Copeland e al. (2004), and Liu and Thomas (2000). Boh sudies focus on expeced fuure earnings only. Meanwhile, i is also differen from Weiss, Naik and Tsai (2008) ha induce shor-run asse capaciy. Fakulas Ekonomi Universias Syiah Kuala 2

3 This sudy invesigaes reurn model by employing several capial markes ha are Asia, Ausralia and US counries. Alhough all hese counries are no comparable in economic progress and capial marke efficiency form, his sudy blends hem. This blending is based upon marke-wide regime shifing behavior concep (Ho and Sequeira, 2007). This concep recommends ha he associaion beween accouning fundamenals and sock price movemens is only based on earnings and firm book value. I also suggess ha highly sock price movemen respons o highly earnings level and vice versa. I could be concluded ha his reacion do no consider marke efficiency form. This sudy is based on wo assumpions. Firsly, sock markes in seleced counries are wihin comparable efficiency level. Sock price variaions a all sock markes acs in he same marke-wide regime behavior and depends on equiy book value and earnings (Ho and Sequeira, 2007). Secondly, cos of ineres represens opporuniy cos for each firm. I describes ha every fund was managed in order o maximize asses usabiliy. This refers o ha managemen always behaves raionally. Research Objecives The main objecive of his sudy is o consruc new reurn model and examine i o obain beer associaion degree. I also invesigaes consisen direcion of each consruc associaion wihin he reurn model. The new reurn model induces forward looking informaion which is no poenial expeced earnings (Weiss, Naik and Tsai, 2008) or muliple earnings only (Liu, Nissim and Thomas, 200), bu i also induces boh of expeced fuure earnings and growh opporuniies. Finally, his sudy examines previously designed model and compares wih he new one. Research Conribuion This sudy conribues o accouning lieraure o creae new reurn model ha is expeced o be more comprehensive, realisic, accurae and beer associaion degree. This sudy has advanages compared o he models of Eason and Harris (99), Liu and Thomas (2000), Zhang (2000), Copeland e al. (2004), Chen and Zhang (2007), and Weiss, Naik and Tsai Fakulas Ekonomi Universias Syiah Kuala 3

4 (2008) as follows. Firs, his sudy is more comprehensive by including a se of raional expeced accouning informaion. I means ha he reurn funcion does no merely rely on accouning daa repored on financial saemens. Second, by inducing forward looking informaion, his model is expeced o be more realisic and closer o economic perspecive. I means ha, in accordance wih forward looking heory, he firm should make raional decision o manage is asses o generae fuure cash flow. The firm mus choose fuure invesmens which give posiive conribuion o fuure cash flow. Fuure cash flow affecs earnings and is change. I refers o earnings capializaion model. Third, his new model becomes more accurae and beer insrumen o predic fuure cash flow. I is useful for invesors o esimae fuure poenial gains by exracing forward looking informaion (Weiss, Naik and Tsai, 2008). Is accuracy is suppored by muliple value drivers (Liu, Nissim and Thomas, 200). Muliple value drivers increase model accuracy as long as hey have informaion synchroniciy o increase value relevance. Las, his sudy has valuable conribuion by creaing new reurn model wih higher associaion degree. I is showed by adj-r 2 which is higher han previous models. Research Benefis This sudy is beneficial o invesors and managemens. From invesor s poin of view, his sudy offers more accurae, comprehensive parameer o predic fuure cash flow (SFAC No., FASB, 978). This is relaed o he relaionship of fundamenal accouning daa and is change wih sock price. Accouning informaion becomes more useful when presened in financial saemens (SFAC No. 5, para. 24, FASB, 984). From managemen s poin of view, his sudy gives more incenive for managemens o manage more raionally heir fuure invesmens giving posiive conribuion o firm equiy value. Managemens and invesors should perceive closely he associaion beween accouning informaion and sock price. From accouning lieraure poin of view, his sudy becomes a rigger o furher sudies, especially o develop new models o achieve higher degree of associaion. Fakulas Ekonomi Universias Syiah Kuala 4

5 The remaining manuscrip is organized as follows. Secion 2 describes he developmen of heoreical reurn model and hypohesis for each model. Secion 3 illusraes empirical research design and research mehods. Secion 4 discusses he resuls of empirical examinaions. And secion 5 depics research conclusions, limiaions and consequences for furher sudies. 2. Lieraure Review, Model and Hypohesis Developmen Earnings Yield and Book value Model ha associaes earnings and book value wih sock marke value or reurn is developed on classical conceps basis. The poin is he usage of accouning informaion o evaluae firm equiy value, marke efficiency, and forecasing analysis. This concep refers o Ohlson (995). This model formulaes ha firm equiy value comes from book value and expeced value of fuure residual earnings. The expeced value can be calculaed from curren discouned value of poenial asses. Every new wealh acquired comes from invesed asses and being refleced in firm book value. Then, firm book value is refleced in sock price. Model of Ohlson (995) indicaes linear informaion dynamic beween book value and expeced residual earnings wih sock price. This model is followed by nex sudies. Lo and Lys (2000), and Myers (999) for he firs ime implemened clean surplus heory. I oulines ha end year book value equals o beginning year book value added by curren year earnings and subraced dividend paid. Model of Lundholm (995) formulaes ha firm marke value equals o equiy capial invesed plus discouned fuure residual earnings. Furher sudies use Ohlson (995) and Lundholm (995) conceps o evaluae firm equiy value and o deermine eiher earnings or firm marke value. Lo and Lys (2000) offer new hypoheical conceps ha firm equiy value is a funcion of discouned fuure earnings and dividend. Dechow, Huon, and Sloan (999) evaluae capial rae of reurn based on residual earnings, while Frankel and Lee (999) add invesors expecaion of minimum profiabiliy. Beaver (999), Hand (200), and Myers (999) confirm ha firm marke value is a funcion of book value and earnings, in accordance wih concep of Ohlson (995). Fakulas Ekonomi Universias Syiah Kuala 5

6 However, he hree researches recommend oher informaion o increase associaion degree of reurn model. Ohlson (200) criicize his former concep by describing oher informaion o increase degree of associaion beween book value and earnings wih firm marke value. Danielson and Dowdell (200) and Aboody, Hughes and Liu (200) specify he oher informaion wih growh rae and reasonable expecaion of fuure earnings. Oher sudies consanly use model of Ohlson (995) wihou criicizing book value and earnings wihin he model. Felham and Ohlson (995; 996) emphasize ha he associaion beween book value and earnings is asympoic; i may be affeced by oher informaion and conservaism in depreciaion. Burgsahler and Dichev (997), under he same model, add concep of asses book value and liabiliies o explain firm marke value beer. Liu and Thomas (2000), and Liu, Nissim and Thomas (200) add muliple facors ino clean surplus model, eiher earnings dis-aggregaion or oher book value and earnings relaed measures. Collins, Maydew, and Weiss (997), Lev and Zarowin (999), and Francis and Schipper (999) ouline ha value relevance beween book value and earnings wih sock marke value or reurn may be preserved. Abarbanell and Bushee (997) and Penmann (998) specifically ha more accouning informaion resul in beer degree of associaion. Boh sudies earnings qualiy improve degree of associaion. Collins, Pincus, and Xie (999) argue similarly and confirm he associaion beween book value and earnings wih sock marke value by eliminaing losing firms. Bradshaw, Richardson and Sloan (2006) modify clean surplus model by adding fuure financing aciviy. Cohen and Lys (2006) and Weiss, Naik and Tsai (2008) add expeced value of fuure poenial earnings ino reurn model. Chen and Zhang (2007) modify heir model wihou discarding book value and earnings. This research, in order o increase degree of associaion, adds exernal environmen facors which may muliply degree of associaion. Pas researches have correlaed book value and earnings wih firm marke value. Rao and Lizenberger (97), and Lizenberger and Rao (972) formulae ha firm marke value is a funcion of book value and earnings and adjusable o liabiliies and produciviy Fakulas Ekonomi Universias Syiah Kuala 6

7 growh. Bao and Bao (989) indicae ha firm equiy value is no merely affeced by earning, bu also by expeced earnings, earnings sandard deviaion and earnings growh. Beaver, Lamber and Morse (980), Collins, Kohari and Rayburn (987), Eason and Harris (99) conclude ha book value and earnings have beer degree of associaion when he earnings are ranked. Earnings and heir changes are deflaed by sock marke value. Warfield and Wild (992) examine furher han Eason and Harris (99) and replace he deflaing facor wih previous year sock marke value. Forward Looking Informaion Forward looking informaion means ha refinemens increase he informaion conen of financial and nonfinancial performance measures regarding fuure financial performance (Dikkoli and Sedaole, 2007). Inducing forward looking informaion is based on raional expecaion hypohesis. Wihin reurn model conex, he essence of his hypohesis is he expeced value of one or more accouning informaion which are comparable wihin a se of informaion (Heijdra and Ploeg, 2002). The benefi and objecive is o obain more effecive informaion se for decision making. I is a more universal insrumen o invesigae he implicaions of new policies for i measures asympoic variance. The value relevance can be eiher in shor-erm or long-erm. Anoher advanage of forward looking informaion is is ransparency and predicive power (Zarb, 2007; Fay, 2009). Shaw (2007) indicaes ha forward looking informaion is able o predic cash inflow and poenial fuure cash flow beer han backward looking informaion. Therefore, i can be used for forecasing and maximizing echnique. Berea and Bozzolan (2006), and Chen, Yee and Yoo (2004) conclude ha inducing forward looking informaion increase predicive power and lessen forecasing error. Dikolli and Sedaole (2007) conclude ha forward looking informaion of non-main earnings increase informaion conen. Moreover, i brings beer indicaor for decision making. Giannoni and Woodford (2007) sae ha forward looking informaion makes forecasing more efficien wihin longer period and predic clearly fuure benefis. Brock, Dindo, and Hommes (2006) Fakulas Ekonomi Universias Syiah Kuala 7

8 conclude ha forward looking informaion drives price equilibrium in he fuure. Wihin reurn model conex, i makes reurn model achieve equilibrium sae. The mapping of accouning researches gives concep o anicipae fuure reasonable expeced values. Beaver, Lamber and Morse (980) iniiae ha heir research include fuure earnings change ino reurn model. This sudy is suppored by Lev and Thiagarajan (993), Abarbanell and Bushee (997), Brown, Foser, and Noreen (985), and Cornell and Landsman (989). Eason and Harris (99) also perform similar sudy, wih fuure expeced reurn is deflaed by previous year sock price as predicor in reurn model. Liu and Thomas (2000) give soluion ha fuure earnings and earning shock improve associaion degree of reurn model. This model offers more effecive model and decrease specifying errors. Copeland, e al. (2004) confirms ha reasonable fuure expeced earnings improve reurn model. Chen and Zhang (2007) specify ha expeced earnings, expeced fuure growh rae, and expeced discoun rae change improve associaion degree of reurn model. Weiss, Naik and Tsai (2008) design heir own reurn model by including forward looking informaion of shor-erm invesmen capaciy. This sudy gives sronger degree of associaion. Forward looking informaion included ino his model consiss of fuure accoun receivables, fuure invenory, fuure profi margin, and fuure cos of good sold. I can be concluded ha inducing reasonable expeced fuure values improves reurn model. Change in Growh Opporuniies Growh opporuniies are included ino reurn model according o model of Ohlson (995). This model complies o clean surplus heory, wih premises as follows. (i) Sock marke value is based on discouned dividend in which invesors ake neural posiion agains risks. (ii) accouning income is pre-deerminisic value. (iii) In addiion, fuure earnings are sochasic. Fuure earnings can be calculaed by previous consecuive earnings. However, invesors may have differen respond agains minimum or maximum profiabiliy. Therefore, growh opporuniies affec earnings or fuure poenial earnings. Fakulas Ekonomi Universias Syiah Kuala 8

9 Rao and Lizenberger (97), Lizenberger and Rao (972), and Bao and Bao (972) conclude ha growh rae and is change improve firm compeiiveness. Higher efficiency increases produciviy, higher produciviy increases sockholders wealh and counry. Rao and Lizenberger (97) and Lizenberger and Rao (972) disclose ha growh opporuniies are relaed direcly wih long-run prospec. Those researches are based on concep of Miller and Modigliani (96) who concluded ha a growing firm is firm wih posiive capial rae of reurn. I also means ha each asse has lower ineres rae han cos of capial. Liu, Nissim and Thomas (200), Aboody, Hughes and Liu (2002), and Frankel and Lee (998) menion ha firm inrinsic value is deermined by growh and fuure poenial growh. Curren growh drives he movemen of fuure residual earnings, while fuure growh lessens reurn model errors by improving associaion degree of reurn model. Lev and Thiagarajan (993), Abarbanell and Bushee (997), and Weiss, Naik and Tsai (2008) indicae ha changes in invenory, gross profi, sales, accoun receivables and he ohers improve fuure poenial growh of earnings. Growh also improves firm equiy value. The sudy concluded ha sock marke value is adjusable o ha firm s growh. Danielson and Dowdell (200) confirm ha growing firm has beer operaion efficiency. Growing firm always has raio beween sock price and book value greaer han one. However, invesors do no perceive sock reurn of growing firm higher han hose of diminishing firm. Chen and Zhang (2007) conclude ha firm equiy value depends on growh opporuniies. Growh opporuniies are a funcion of scaled invesmen and affecs fuure poenial growh. The inducemen of growh opporuniies argues ha earnings elemens alone are no sufficien o explain. The explanaion becomes more comprehensive when exernal environmen, indusry and ineres rae are included o deermine earnings and fuure earnings. Fakulas Ekonomi Universias Syiah Kuala 9

10 Change in Discoun Rae Change in discoun rae concep is based on model of Ohlson (995) simplificaion. This model assumes ha invesors ake neural posiion agains fixed risks and ineres rae. The simplificaion is modified by Felham and Ohlson (995; 996), and Baginski and Wahlen (2000) by inducing ineres rae because i affecs shor-erm and long-erm earnings power. Change of ineres rae also affecs invesor s percepion abou earnings power, because ineres rae provides cerainy of fuure earnings. Rao and Lizenberger (97), and Lizenberger and Rao (972) posi ha firm equiy value depends on discouned value of fuure earnings. This value is affeced by pure ineres rae. Ineres rae changes operaion efficiency. Operaion efficiency alers earnings. Danielson and Dowdell (200), and Liu, Nissim and Thomas (200) sae ha discoun rae modifies firm equiy value for i changes he growh of asses and capial book value. If weighed ineres rae of asses and capial was higher han pure ineres rae, he firm may generae earnings. Obaining new debs or capial can decrease weighed ineres rae. Burgsahler and Dichev (997) indicae ha firm equiy value can be increased according o adapaion heory by modifying ineres rae, for insance obaining alernaive invesmen wih lower ineres rae. Aboody, Hughes and Liu (2002), Frankel and Lee (998), Zhang (2000) and Chen and Zhang (2007) argue ha earnings growh is deermined by ineres rae. Ineres rae serves as adjusmen facor for firm operaion, by selecing favorable ineres rae o make efficien operaion. Model of Equiy Value Earnings play imporan role o show he firm endency o grow or o erminae is operaion. Valuaion model measures he creaion of equiy capial invesmen on coninuaion or erminaion of firm operaion framework (Burgsahler and Dichev, 997). Equiy value model developed by Zhang (2000) and Chen and Zhang (2007) is described as follows. Fakulas Ekonomi Universias Syiah Kuala 0

11 Fakulas Ekonomi Universias Syiah Kuala Wih V is firm equiy value financed during period (end period ), X is earnings during period, B is equiy book value, E (X + ) is fuure expeced earnings, k is earnings capializaion facor, P is probabiliy of operaion erminaion, C is probabiliy of operaion coninuaion, q X /B - is profiabiliy, based on ROE, period. and g is growh opporuniies, Chen and Zhang (2007) formulae equiy value as follows. ) (.. ) (. ) ( q C g B q P B X ke V... () This model () formulaes ha equiy value (V ) is correlaed wih fuure expeced earnings (E (X + ), fuure earnings capializaion facor (k), probabiliy o erminae operaion (P(q )), and probabiliy o coninue operaion (C(q )). I indicaes ha equiy value is equal o curren operaion (q ) added by growh value which can be posiive or negaive (g ). I also indicaes ha when v increased, hen g increase along wih invesed asses. Increase of v makes discoun rae r o fall which indicaes easier fuure cash flow. Therefore, firms wih g increase and r decrease are firms hose are able o generae earnings. Model of Sock Reurn wih Inducing Forward Looking Informaion Using model () as basis, forward looking model for expeced earnings is as follows. r V B v g V B C B B V B V EX V X R 3... (2) The nex is inducing forward looking informaion of expeced profiabiliy ino model (3) o obain model (3) as follows. r V B v Eg V B C g V B C B B V B V EX V X R 3... (3) Equaion (3) infers ha sock reurn is a funcion of he following facors: () earnings yield (X /V - ), (2) expeced earnings (EX + /V ), (3) change in equiy capial (ΔB /B - ), (4) change in growh opporuniies (Δg ), (5) change in expeced growh

12 opporuniies (ΔEg + ), and (6) change in discoun rae (Δr ). Up o his sage, model was developed incremenally, forward looking variables are included ino model one by one. Though, acually i can be done muually exclusive. Hypohesis Developmen Earnings Yield Earnings yields (X ) show he value generaed from beginning year capial. Earnings yield is deflaed by he opening value of curren equiy capial which generaes curren earnings. According o model (3), if earnings yields increased, sock reurn increases and vice versa. Therefore, i be concluded ha earnings yield associaes wih sock price posiively (Rao and Lizenberger, 97; Lizenberger and Rao, 972; Bao and Bao, 989; Burgsahler and Dichev, 997; Collins, Pincus and Xie, 999; Collins, Kohari and Rayburn, 987; Cohen and Lys, 2006; Liu and Thomas, 2000; Liu, Nissim and Thomas, 200; Weiss, Naik and Tsai, 2008; Chen and Zhang, 2007; Ohlson, 995; Felham and Ohlson, 995; Felham and Ohlson, 996; Bradshaw, Richardson and Sloan, 2006; Abarbanell and Bushee, 997; Lev and Thiagarajan, 993; Penman, 998; Francis and Schipper, 999; Danielson and Dowdell, 200; Aboody, Hughes and Liu, 200; Eason and Harris, 99; and Warfield and Wild, 992). Using mahemaical properies from equaion (3), he associaion beween earnings yields (X /V - ) and sock reurn (R ) should be posiive. I is caused by dr dx V, and /V - ha is always greaer han zero, hen dr /dx is always posiive. Therefore, my alernaive hypohesis is saed as follows. H A : Earnings yield associaes posiively wih sock reurn Expeced Earnings Similar o earnings yield, expeced earnings (EX + ) shows value which is expeced o be generaed in he fuure from end year capial. Expeced earnings are normalized by closing value of curren capial, so ha poenial fuure earnings growh is shown. Inducing expeced earnings is based on forward looking concep which saes ha reasonable fuure expeced earnings influences posiively he movemen of sock price or cerain measure (Burgsahler and Dichev, 997; Cohen and Lys, 2006; Weiss, Naik Fakulas Ekonomi Universias Syiah Kuala 2

13 and Tsai, 2008; Chen and Zhang, 2007; Ohlson, 995; Felham and Ohlson, 995; Felham and Ohlson, 996; and Aboody, Hughes and Liu, 200). The influen mechanism is equal o earnings yield, so ha he associaion beween expeced earnings (EX + /V ) and sock reurn is posiive. I is also caused by dr, dex V and /V ha is expeced o greaer han zero, hen dr /dex + is always posiive. We summarize alernaive hypohesis saemen as follows. H A2 : The change in expeced earnings yield associaes posiively wih sock reurn Change in Equiy Capial The change in equiy capial is cener of firm value measuremen. I is measured by ΔB /B - which is change in curren equiy value divided by beginning value of curren equiy. Because of ΔB /B - =v[δb /V - ], he change of equiy value increases as equiy capial does, hen refleced in sock reurn. In oher words, he change of sock reurn is in accordance wih he change of earnings afer denominaed by opening value of curren capial (V - ). Therefore, v is always posiive and greaer han zero. I means ha change in equiy capial associaes posiively wih sock reurn (Rao and Lizenberger, 97; Lizenberger and Rao, 972; Bao and Bao, 989; Burgsahler and Dichev, 997; Collins, Pincus and Xie, 999; Collins, Kohari and Rayburn, 987; Cohen and Lys, 2006; Liu and Thomas, 2000; Liu, Nissim and Thomas, 200; Weiss, Naik and Tsai, 2008; Chen and Zhang, 2007; Ohlson, 995; Felham and Ohlson, 995; Felham and Ohlson, 996; Bradshaw, Richardson and Sloan, 2006; Abarbanell and Bushee, 997; Lev and Thiagarajan, 993; Penman, 998; Francis and Schipper, 999; Danielson and Dowdell, 200; Aboody, Hughes and Liu, 200; Eason and Harris, 99; and Warfield and Wild, 992). Using mahemaical properies from equaion (3), he associaion beween change in equiy capial and sock reurn should be posiive. I is caused by dr db B V B B B V B, and wih B - /B - greaer han /(V - B - ), hen Fakulas Ekonomi Universias Syiah Kuala 3

14 dr /db should be posiive and greaer han zero. I is summarized as alernaive hypohesis as follows. H A3 : Change in equiy capial associaes posiively wih sock reurn Change in Growh Opporuniies Fuure equiy value depends on change in growh opporuniies (Δg ). Sock reurn depends on wheher a firm grows or no. If a firm grown, i increases is equiy value and simulaneously sock reurn increases. This growh concep is suppored by growh adjusmen process using B - /V -. Because of a growing firm is able o generae earnings from is invesed asses. I indicaes ha asses grow in differen pace han equiy value. Therefore, growh opporuniies (Δg ), afer being adjused by B - /V - associaes posiively wih sock reurn (Rao and Lizenberger, 97; Lizenberger and Rao, 972; Bao and Bao, 989; Weiss, Naik and Tsai, 2008; Ohlson, 995; Abarbanell and Bushee, 997; Lev and Thiagarajan, 993; Danielson and Dowdell, 200; and Aboody, Hughes and Liu, 200). The alernaive hypohesis is saed as follows. H A4 : Change in growh opporuniies associaes posiively wih sock reurn Change in Expeced Growh Opporuniies Fuure firm equiy value is influenced by he change in expeced growh opporuniies (ΔEg + ). Is explanaion is equal o growh opporuniies. The associaion beween change in expeced growh opporuniies (ΔEg + ) is also posiive (Rao and Lizenberger, 97; Lizenberger and Rao, 972; Bao and Bao, 989; Weiss, Naik and Tsai, 2008; Ohlson, 995; Abarbanell and Bushee, 997; Lev and Thiagarajan, 993; Danielson and Dowdell, 200; and Aboody, Hughes and Liu, 200). Similarly, alernaive hypohesis is saed as follows. H A5 : Change in expeced growh opporuniies associaes posiively wih sock reurn Change in Discoun Rae Discoun rae shows fuure cash flow valued by cos of capial. The change in discoun rae (Δr ) affecs fuure cash flow hen modifies sock reurn in urn. The higher discoun rae, he lower fuure cash flow and vice versa. I means ha change in discoun rae associae negaively wih sock price variaions (Rao and Lizenberger, 97; Lizenberger and Rao, 972; Burgsahler and Dichev, 997; Liu, Fakulas Ekonomi Universias Syiah Kuala 4

15 Nissim and Thomas, 200; Chen and Zhang, 2007; Felham and Ohlson, 995; Felham and Ohlson, 996; Danielson and Dowdell, 200; and Eason and Harris, 99). Using mahemaical properies from equaion (3), he coefficien of Δr should be negaive. I is caused by dr dr v 3 B V uni of invesmen, bu because of wih B - /V - greaer han zero and v 3 is one posiive r, hen k summarized in he following hypohesis saemen. V B should be less han zero. I is H A6 : Change in discoun rae associaes negaively wih sock reurn 3. Research Mehod Populaion and Sample All reurn-relaed-cash flow facors in his sudy (earnings yield, expeced earnings yield, change in equiy, and change in growh opporuniies and is expeced value) are obained from financial saemens. Expeced daa or prospecus for nex year is included wihin noes of financial saemens. All daa are available a OSIRIS daabase. The change of discoun rae daa are obained from cenral bank official websie of each counry, even hough financial saemens usually conain long-erm debs or long erm ineres rae. The change of discoun rae is proxies by long-erm obligaion ineres rae from cenral bank of each counry. Then, his sudy exracs sock price and reurn for each firm a each sock marke direcly. This sudy covers observaion arges of all Asia-Pacific and US. I denies culural and sock marke efficiency problem wih concep of marke-wide regime shifing behavior approach (David, 997; Veronesi, 999; Conrad, Cornel and Landsman, 2002; and Ho and Sequeira, 2007). I indicaes ha he movemen of reurn associaion mus be he same for each sock marke and only relies on accouning informaion. I saes ha wihin he same cerain classificaion, sock marke movemen as respond o accouning informaion should be equal. Fakulas Ekonomi Universias Syiah Kuala 5

16 Sampling Mehods This sudy uses purposive sampling, he sample is obained under cerain crieria. The crieria are as follows. Firs, firms are in manufacure and rading secors, eliminaing financial and banking secors. This sudy eliminaes financial and banking secors because hey are regulaed ighly. Second, opening and closing equiy book value mus be posiive (B i- >0; B i >0). Firms wih negaive equiy book value end o go bankrupcy. Third, accouning informaion and is expecaion or prospecus is available. They are required for inducing forward looking informaion. Fourh, firm socks are raded acively. Sleeping socks would disurb conclusion validiy. Variables Measuremen and Examinaion This sudy designs model o improve model of Chen and Zhang (2007) by inducing forward looking informaion. Briefly, his sudy is carried ou in consecuive sages as follows. Firs, examine using model of Chen and Zhang (2007). Second, examine by our newly developed model by inducing backward looking and forward looking informaion. Nex, his sudy compares he resuls of boh previous examinaions. The firs examinaion is using model of Chen and Zhang (2007). I uses linear regression examinaion based on model as follows. R i x qˆ bˆ gˆ rˆ e... (4) i i i i Wih R i is annual sock reurn for firm i during period, measured since he firs day of opening year period - unil one day afer financial saemen publicaion or, if any, earnings announcemen period ; x i is earnings firm i during period, calculaed by earnings acquired by common sock holders during period (X i ) divided by equiy marke value during opening of curren period (V i- ); qˆ i ( qi qi ) Bi / Vi is he change in profiabiliy firm i during period, deflaed by equiy book value during opening of curren period and profiabiliy calculaed using formula q i =X i /b i- ; b ˆ [( B B ) / B ]( B / V ) is equiy capial or proporional change in equiy i i i i i i i i Fakulas Ekonomi Universias Syiah Kuala 6

17 book value for firm i during period, adjused by one minus raio book value and marke value during curren period. This adjusmen is needed o balance accouning book value and marke value; g ˆi ( gi gi ) Bi / Vi is change in growh opporuniies firm i during period ; r ˆi ( ri ri ) Bi / Vi is change in discoun rae during period ;,,,, and are regression coefficien; and e i is residual. The second examinaion is inducing expeced earnings, using model as follows. R i X EXˆ ˆ ˆ ˆ rˆ e... (5) i ˆ i qi bi g i Wih addiional noes, EX i is by expeced earnings firm i during period + calculaed by dividing following period expeced earnings (EX i+ ) wih curren period equiy book value (V ). The hird examinaion is inducing expeced growh opporuniies ino model (4), so ha he resul is as following model. R i X qˆ bˆ gˆ Egˆ rˆ e... (6) i i ˆ i i Wih addiional noes, E g i are expeced growh opporuniies for firm i during period + measured afer considering muliplier effec of growh opporuniies and adjused by raio beween book value and marke value of curren equiy. Unil model (6) inducing forward looking variables is performed muually exclusive. Afer ha, all forward looking variables are induced simulaneously using model as follows. R i i i qi bi g i Eg i i X EXˆ ˆ ˆ ˆ ˆ rˆ e... (7) Lineariy examinaion is conduced for each model. The reason is ha all models are linear regression and require freedom of normaliy, heeroscedasiciy, and mulicollineariy. As Gujarai (2003) saes ha linear regression model mus conrol is residual errors o preven bias. i i i i i i Fakulas Ekonomi Universias Syiah Kuala 7

18 Sensiiviy Examinaion Sensiiviy examinaion for cross-secional daa which has been examined by model (4) unil (7) is performed by sample arrangemen ino various pariions. Pariioning crieria are raio beween equiy book value and sock marke value. This examinaion is aimed o show model consisency wihin various marke levels. Consisency is also expeced o be shown a various marke changes. Our reurn model examines consisency agains sysemaic risks, and no ye agains idiosyncraic risks. The examinaion is carried ou by spliing sample ino quiniles or deciles according o raio of book value and marke value. Robusness Examinaion Beside sensiiviy examinaion, his sudy also examines he model robusness. The objecive is o infer he consisency of reurn model no only considering sysemaic risks bu also idiosyncraic risks. Robusness examinaion employs abnormal reurn. Idiosyncraic risks are verified when fundamenal accouning informaion was relaed o abnormal reurn. In oher words, i also anicipaes invesor s overreacion agains accouning informaion. In his sudy, abnormal reurn refers o par of abnormal reurn which can no be explained by main facors as explained in model of Fama and French (992, 993, dan 995). This model formulaes ha reurn as a facor of ME (marke equiy) which is marke based measuremen, and BE/ME (book-o-marke) which is raio beween book value and marke value of each share. Therefore, model of Fama and French (992, 993, dan 995) formulaion is as follows. R i BE ln( ME) i ln ei... (8) ME i Model (8) resuls residual error, noed as e i. I may be used as abnormal reurn indicaor (Fama and MacBeh, 973), and serves o examine incremenal explanaory power (Chen and Zhang, 2007). I is expeced o explain addiional explanaory power of all independen variables in all models. Fundamenal accouning informaion should able o explain sock price movemens or has relevance value wih earnings. Fakulas Ekonomi Universias Syiah Kuala 8

19 4. Analysis, Discussion and Findings This secion describes daa analysis, discussion and research findings. I sars wih descripive saisics, analysis, discussion and ends wih research findings. Descripive saisics iniiae his descripion. Descripive Saisics This sudy acquires sample daa as much as 6,32 (25.45%) from all populaion of 24,095 (00.00%). The populaion comes from all sock marke in Asia, Ausralia and Unied Saes of America. The sample daa period is A number of daa mus be excluded, he number and reason are as follows. Firs, 8,939 (37.0%) are due o sock price or sock reurn daa incompleeness. Second, 66 (2.74%) are caused by earnings daa unavailabiliy. Third, 8,038 (33.36%) are due o expeced earnings and growh are no presened. Fourh, 67 (0.69%) are caused by negaive earnings. Fifh, 20 (0.50%) are due o exreme daa exclusion. Las, 38 (0.6%) are caused by abnormal reurn ha canno be calculaed using model of Fama and French (992, 993, and 995). Final sample has fulfilled all required crieria. This sudy canno obain firms wih negaive book value, because heir sock price daa is incomplee. Therefore, he crierion which excludes firms having negaive book value is auomaically accomplished. The acquired daa and he exclusion are presened in Table as follows Inser Table abou here From sample, his sudy analyzes o examine daa iniial endency. The resul of descripive saisics is shown in Table 2. I can be inferred as follows. Reurn for one year period (R i ) is hen, i degrades during he following periods, for reurn (R i4 ) becomes The decrease occurs in all level of percenile 25 (from o ) and percenile 75 (from.2500 o 0.286). I indicaes ha firm marke value in longer period becomes closer o is inrinsic value. Wih his proximiy, fundamenal accouning informaion is expeced o be refleced in firm marke value. Fakulas Ekonomi Universias Syiah Kuala 9

20 Since earnings daa used in his sudy are earnings afer ax (x i ), i requires firms wih profi. Therefore, he minimum value is Mean value is , median value is , and sandard deviaion is The median value is in he lef side of mean. I shows ha here are some firms having enormous earnings. However, his condiion is no a problem since is sandard deviaion is less han one. The reurn daa indicaes similar endency. Therefore, he correlaion beween boh variables is possible. The oher variables, change of earnings power (Δq i ) and change of growh opporuniies (Δg i ) also show similar endency as earnings. Meanwhile, change of discoun rae shows inversed endency. Such phenomena are expeced Inser Table 2 abou here The change of expeced earnings may move posiively or negaively. Declined prediced firms show negaive flucuaion. Expeced earnings have minimum value of , maximum value of. 838, mean of and median of Sandard deviaion shows as much as relaively small sandard error of esimae. The change of growh opporuniies (EΔg i ) shows comparable endency. I indicaes ha all expeced values flucuae in accordance wih sock price or reurn. Wih such iniial indicaion, he associaion beween expeced value of accouning informaion and firm marke value is posiive. Forward looking informaion probably associaes wih sock price or reurn. Firm book value (B i ), raio beween marke price and book value (PB i ), and sock marke value (V i ) are always posiive. This sudy eliminaes firms wih negaive book value and having losses. Even hough exreme values have been eliminaed, maximum values for B i and V i sill show grea numbers. I especially occurs in developing counries where sock marke value deviaes from is book value. Wih mean of and median of B i is in accordance wih sock marke value. Such indicaion does no disurb model validiy. Paern of such is also shown by firm inrinsic value (V i ) which is refleced in closing value of sock marke price. Fakulas Ekonomi Universias Syiah Kuala 20

21 Abnormal reurn calculaed wih model of Fama and French (992; 993 and 995) shows mean of for AR i, AR i2, AR i3, dan AR i4. I means ha esimaion of abnormal reurn is valid mahemaically. The sandard deviaion of abnormal reurn becomes smaller over ime, from (AR i ) become (AR i4 ). The sandard deviaion indicaes ha abnormal reurn flucuaes in he same paern as firm marke value. Abnormal reurn flucuaion is also similar wih reurn and earnings (x i ), change of earnings power (Δq i ), and change of growh opporuniies (Δg i ). Such indicaion suppors our hypoheses. Basic Model (Chen and Zhang, 2007) Analysis As firs sage, his sudy examines model of Chen and Zhang (2007), i is henceforh called he basic model (model 4). I consrucs five main facors which associae wih reurn. They are earnings (x i ), change in firm book value (Δb i ), change in earnings power (Δq i ), change in growh opporuniies (Δg i ), and change in discoun rae (Δr i ). The resul analysis is presened in Table 3 as follows Inser Table 3 abou here This basic model examinaion serves as iniial invesigaion of associaion beween five facors wih sock reurn. The resul shows ha earnings (x i ), firm book value (Δb i ), and growh opporuniies (Δg i ) are consisenly above % confirmed ha hey associae wih sock reurn for various reurn specificaions (R i unil R i4 ). This sudy is failed o confirm he associaion beween earnings power (Δq i ) wih sock reurn, unlike Chen and Zhang (2007) who confirm i consisenly. Meanwhile, change in discoun rae (Δr i ) is no consisenly confirmed. Therefore, his sudy concludes ha model of Chen and Zhang (2007) is adequaely suppored excep for earnings power. Degree of associaion shows F- value of and significan a level %. This basic model has reurn ype R 2 of 2.82% for R i, and lower for he ohers. Is adj-r 2 value is 2.74%. Fakulas Ekonomi Universias Syiah Kuala 2

22 The resul of firs sage examinaion is ineresing. Earnings power and change in discoun rae are no confirmed heir associaion wih sock reurns. Even hough he basic model is sill able o conclude he associaion beween accouning informaion and reurn, i is no flexible enough or rigid because he wo variables above were no confirmed. Therefore, his resul gives sufficien reason for furher sage of examinaion. This sudy suspecs ha forward looking informaion can be induced ino model. Inducing Change in Expeced Earnings ino Model This model iniiaes he inducing of forward looking informaion as basic model modificaion. This model, hereafer, is called model 5. The resul of model 5 examinaion is presened in Table 4 as follows Inser Table 4 abou here The resul shows ha hypohesis H A is suppored. I means ha earnings yield associaes posiively wih sock price variaions. Hypohesis H A3 which saes ha change in equiy capial associaes wih sock reurn is suppored. The same hing goes o hypohesis H A4 which saes ha change in growh opporuniies associaes wih sock reurn. The hree hypoheses are suppored in all reurn ypes R i R i4. Furhermore, he resul indicaes ha change in expeced earnings associaes wih reurn wih -value of and is significan a level % for R i4 ype. Therefore, change in expeced earnings (ΔEx i ) associaes posiively wih sock reurn or hypohesis H A2 is suppored. The confirmaion in R i4 reurns ype because change in expeced earnings is measured annually. Then i associaes wih sock reurn which is also in annual measure. This examinaion canno confirm hypohesis H A6, ha change in discoun rae explain sock price movemens. This model 5 has R 2 value of 2.82% for R i ype, and lower for oher reurn ypes. Is adj-r 2 value is 2.74%. Fakulas Ekonomi Universias Syiah Kuala 22

23 Inducing Change in Expeced Growh opporuniies ino Model The hird analysis induces he change in expeced growh opporuniies. This analysis uses model 6. Inducing he change in expeced growh opporuniies was performed separaely for i is muually exclusive. The resul is presened in he following Table 5. The resul indicaes ha H A, H A3, and H A4 are consisenly suppored for R i R i4 reurn ypes. This model examines he associaion beween he changes in expeced growh opporuniies (ΔEg i ) wih reurn which is shown o be posiive and significan a level % for R i R i4 reurn ypes. Thus, H A5 is suppored. Furhermore, he change in expeced growh opporuniies is posiive and consisen compared o previous analysis. Therefore, his sudy concludes ha change in growh opporuniies eiher in backward or forward looking perspecive explains firm marke value Inser Table 5 abou here This model provides beer proof wih R 2 value of 3.92%, and adj-r 2 value of 3.82%. Compared o previous models, his model has greaer predicive power han previous model. The difference is abou.5%. Inducing Change in Expeced Earnings and Expeced Growh Opporuniies The fourh analysis induces he change in expeced earnings and he change in growh opporuniies simulaneously. The model used in his analysis is model 7. The resul is presened in he following Table 6. I indicaes ha hypoheses H A, H A3, H A4, and H A5 are consisenly suppored for all R i R i4 reurn ypes. I also shows ha he change in expeced earnings (ΔEx i ) are no confirmed is associaion wih sock reurn, bu he change in growh opporuniies (ΔEg i ) associaes posiively and significanly a level % for all R i R i4 reurn ypes. Therefore, H A2 is no suppored bu H A5 is suppored. Such indicaion is caused by mulicollineariy beween boh variables. However, his sudy concludes ha he informaion of change in growh opporuniies eiher in backward or forward looking perspecive explains firm marke value Inser able 6 abou here Fakulas Ekonomi Universias Syiah Kuala 23

24 Model 7 wih inducing he change in expeced earnings and growh opporuniies shows increase of R 2 as much as 4,0% and adj-r 2 as much as 3.90%. Therefore, his model has beer predicive power compared o previous models. Is increases are around 2%. Sensiiviy Examinaion Resul This sudy analysis model of inducing forward looking informaion based on he quinile of PB raio. Model 5 and 6 are analyzed while model 7 did no because model 7 conains collineariy beween he change in expeced earnings (ΔEx i ) and he change in expeced growh opporuniies (ΔEg i ). The sample is arranged in five pariions and he resul is presened in Table 7 as follows. Table 7 panel A exhibis inducing he change in expeced earnings based on PB quinile. I indicaes ha hypohesis H A2 which saed ha he change in expeced earnings associaes posiively wih reurn is suppored. This is shown in high level PB for all reurn ypes wih significance level of %, excep for R i reurn ype whose significance level of 5%. I is also shown in medium PB level for R i and R i4 reurn ypes wih significance level of, consecuively, 5% and 0%. Meanwhile, H A, H A3, and H A4 are suppored consisenly as basic examinaion previously. Panel B displays inducing he change in growh opporuniies based PB quinile. The resul indicaes ha hypohesis H A5 which saed ha he change in expeced growh opporuniies associaes posiively wih reurn is suppored. I is shown in high PB level wih significance level of % for all reurn ypes. For reurn ype of R i wih medium PB level is also suppored wih significance level of 0%. Hypoheses H A, H A3, and H A4, are once again suppored consisenly as previous examinaion. Examinaion using sample pariioning based on PB level shows ha hypohesis H A6 which saes ha discoun rae associaes negaively wih sock price is suppored, eiher in panel A or B. I is shown in low, low-medium, medium, and medium-high PB level wih significance level of 5% and 0%. Moreover, his examinaion using PB pariioning show Fakulas Ekonomi Universias Syiah Kuala 24

25 increase of R 2 around 5%-25% and adj-r 2 around 4%-24%. Therefore, his sensiiviy model has beer predicive power han previous models Inser Table 7 abou here Robusness Examinaion All examinaion resuls of model 5-6 which uses reurn are re-examined using abnormal reurn. This examinaion is aimed o idenify he robusness of associaion for all confirmed variables and invesigaes is accordance wih heory for unconfirmed variables. This examinaion does no only anicipae sysemaic risks bu also idiosyncraic risks. The calculaion of abnormal reurn is based on concep of Fama and French (992; 993 and 995). The regression for all reurn ypes indicaes ha ln(me i ) associaes negaively wih reurn ypes of R i, R i2, and R i3 wih significance level of %, and no significan for R i4 reurn ype. Meanwhile, ln[(be/me) i ] associaes negaively wih all ypes of reurn wih significance level of %. The adj-r 2 value for R i is 3.3%; R i2 is 6,6%; R i3 is 6,%; and R i4 is 8,9%. The model of Fama and French complee resul is presened in Table 8 as follows Inser Table 8 abou here The residuals from four regressions above serve as abnormal reurn. Then his abnormal reurn serves as dependen variable o examine addiional predicive power. The complee resul of robusness examinaion is presened on Table 9 as follows. The resul of model 5 panel A which induces he change in expeced earnings confirms all hypoheses. All hypoheses H A, H A2, H A3, H A4, H A5, and H A6 are suppored a significance level of % or 5% for all R i -R i4 reurn ypes. Panel B which induces he change in expeced growh opporuniies shows he same resul. All hypoheses H A, H A2, H A3, H A4, H A5, and H A6 are suppored wih significance level of % for all R i -R i4 reurn ypes. This robusness examinaion shows he highes degree of associaion for R i reurn ype wih R 2 as mush as Fakulas Ekonomi Universias Syiah Kuala 25

26 5.6% and adj-r 2 as much as 5.05% for R i reurn ype. Oher reurn ypes show lower figures Inser Table 9 abou here Discussion All examinaions show ha associaion and is direcion beween accouning fundamenals and sock price movemens as hypohesized are suppored. This secion describes each variables inerpreaion and concludes in research finding. Earnings yields and Change in Expeced Earnings Earnings yield and change in expeced earnings associae posiively wih firm marke value. This sudy suppors classical concep (Ohlson, 995), along wih is derivaives sudies Lo and Lys (2000), Francis and Schipper (999), Meyers (999), Bradshaw, Richardson and Sloan (2006), Cohen and Lys (2006), Bradshaw and Sloan (2002), Bhaacharya, e al. (2003), Collins, Maydew and Weiss (997), Givoly and Hayn (2000), Kolev, Marquad and McVay (2008), and Weiss, Naik and Tsai (2008). Evenhough Ohlson (995) has some weakness ha earnings are disurbance when measuring firm marke price, his sudy concludes ha earnings is sill as a relaed-cash flow facor of firm value. Therefore, his sudy indicaes ha earnings are indicaor of value added wihin accouning maers, and are absoluely refleced in marke value. The reflecion of earnings in sock price variaions implies ha earnings are fundamenal signal (Ohlson, 995; Felham and Ohlson, 995, 996). This sudy suggess ha his fundamenal signal comes from he naure of earnings which serve as driver of firm performance. Earnings as driver of firm performance and hen sock price movemens can be viewed as poenial. The users of financial saemens absorb his poenial as a relaedcash flow facor of firm value. This sudy suppors he concep of recursion heory (Serling, 968) which saes ha firm value can be idenified from firm book value and earnings. Their values are manifesed in sock price movemens. Finally, his sudy concludes ha book value and accouning earnings associaes wih sock price variaions. Fakulas Ekonomi Universias Syiah Kuala 26