27-08-2012, 11:20 AM
Value Relevance of Published Financial Statements- with Special Emphasis on Impact of Cash Flow Reporting
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Abstract
This paper aims at determining the value relevance of financial reporting. “Value
relevance” implies ability of the financial information contained in the financial statements
to explain the stock market measures. This study aims at explaining likely impact of
financial reporting by listed companies on the market prices of their shares.Our study
reveals that value relevance of published financial statements, per se, is negligible.
However, ratios based on these financial statements show significant association with stock
market indicators. Despite their widespread use and continuing advancement in the
financial reporting practices, there is some concern about their not carrying enough value in
the eyes of the shareholders or investors. From this point of view, value relevance of
published financial statements becomes a primary focus of interest. Through our study, we
have also tried to explore the value relevance as well as value additivity of cash flow
reporting which was introduced in Indian markets in the financial year 2001-02. Cash flow
reporting, in India, is still in its nascent stages. The results of our investigation depict
negligible value being added by cash flow reporting.
Introduction
In the accounting literature, lots of studies have been done in the area of value relevance of financial
reporting. Different studies have explored the value relevance of various financial data reported in
corporate financial statements (Cheng and Yang, 2003; Sloan, 1996; Hribar and Collins, 2002).
Researches on value relevance of financial reporting are motivated by the fact that listed
companies use financial statements as one of the major medium of communication with their equity
shareholders and public at large. Further, lot of hard work is done by stock market regulators and
accounting standard setters in improving the quality of financial reporting and increasing the
transparency level in financial reporting.
In this study, value relevance of Balance sheet, Income statement and Cash flow statement has
been probed with the help of certain key figures contained in these statements such as, net worth, PAT,
cash from operating activities, etc. further, it has been endeavored to investigate the relative value
relevance of information contained in the Cash Flow Statement vis-à-vis financial information
contained in Balance Sheet and Profit & Loss Account. It may be noted that this study in done in the
context of Indian market. Following previous studies in the field, value relevance implies ability of the
financial information contained in the financial statements to explain the stock market measures.
Literature Review
Ball and Brown (1968) were the first to highlight the relationship between stock prices and information
disclosed in the financial statements. Empirical research on the value relevance has its roots in the
theoretical framework on equity valuation models. Ohlson(1995) depicted in his work that the value of
a firm can be expressed as a linear function of book value, earnings and other value relevant
information.
Amir et al. (1993) were the first to use the term “value relevance” in the context of information
content of accounting figures. An accounting figure/ratio is value relevant is it has the significantly
strong predicted association with the stock prices and stock market indicators such, price-earnings
(P/E) or price to book (P/B) ratios. Misund et al. in their study on the value relevance of accounting
figures in the international oil and gas industry concluded that all accounting figures are value relevant,
be it cash or accrual based. Mingyi Hung (2000) in his paper on “Accounting Standards and Value
Relevance of Financial Statements: An International Analysis” concluded that the use of accrual
accounting (versus cash accounting) negatively affects the value relevance of financial statements in
countries with weak shareholder protection. This negative effect, however, does not exist in countries
with strong shareholder protection.
Database & Methodology of the Study
The sample, for the purpose of our study, consists of the 24 blue chip Indian companies comprised in
BSE Sensex (India’s major stock market index). The reason for choosing these companies for the
purpose of our study is that big companies are expected to be more transparent in their financial
reporting practices and also, stock market is perceived to be more responsive and sensitive in case of
these companies. Further, though Sensex comprises of 30 companies, our sample size has been
restricted to 24 companies because of the fact that we have covered the time frame of last 10 years viz,
1996-97 to 2005-06 and for the remaining 6 companies data was not available for all the 10 years.
Hence, in order to have the balanced panel, those six companies have been excluded from the purview
of our study. The list of the companies included in our sample is given in Appendix I.
Conclusions
This study has endeavored to establish the value relevance of Financial Statements of listed companies
in India. It has also tried to bring out the value relevance and value additivity of Cash Flow Statement
prepared according to Accounting Standard-3 promulgated by ICAI and made mandatory by SEBI in
Financial Year 2001-02 for all listed Indian companies. For the purpose of this study we empanelled
top twenty-four Indian companies listed on BSE and forming part of BSE –Sensex as on 12/3/2007 for
analysis.
The results of our study depict that financial statements, per se, have negligible value relevance
as far as stock market reactions are concerned. Also value additivity of Cash Flow Statement is shown
as negligible in this study. However, one interesting point is highlighted by our study that although the
key figures reported by Financial Statements are showing almost nil value relevance for equity
investors, but the ratios based on those figures are showing significant value relevance for equity
investors.
Based on our research findings, we conclude that Indian investors, generally, focus on short
term capital gains, and tend to be speculative or irrational for unusual events, instead of using
published financial data in stock valuation. Alternatively, this probability may not be negated that they
deter considering financial statements to be true & transparent enough to base their stock market
decisions. In the last six –seven years, ICAI has developed and issued set of accounting standards to
ensure improvement in the quality of financial reporting.