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Abstract
This study examines the
informativeness of accounting information to three classes
of shareholder value; high, medium and low. The results
indicate that shareholder value adjusts positively a target
level according to the five categories of financial ratios.
This shows a high degree of informativeness of accounting
information to shareholders in Egypt. In general, the
results show that shareholders in the three classes are
quite affected by the firms’ assets efficiency and
profitability. In addition, shareholders do not appreciate
liquidity and cost elements. Shareholders in the low class
in particular do not appreciate the benefits of costless
financing and prefer short-term debt over long-term debt
financing.
I. Introduction
The accounting information is
considered the basic type of information to be released to
firms’ stockholders. The literature utilized many forms of
accounting information, the most common of which is the
financial ratios that date back to over a century ago.
Financial ratios provide the basic accounting information to
various decision makers. Many studies assumed a close
association between certain accounting information and stock
market characteristics such as the effects of accounting
information on stock returns and on stock risk. This
association implies a degree of informativeness to some
extent. That is, firms’ investors are influenced, with
varying degrees, by the revealed information.
In this study, the informativeness
of the accounting information is examined for three classes
of firms which are high, medium and low market-to-book ratio
as an indicator of shareholder value. Studies such as
Peasnell,, 1982 and Östermark & Aaltonen, 1995 examined
certain accounting information (in the form of financial
ratios) that are quite sophisticated to the typical
investors to reach and to be influenced by. In this study,
the true meaning of the informativeness is examined using
the most usable forms of financial ratios.
Why accounting information in
transition market?
The study of accounting
information is significant to transitional markets for two
reasons. First, transitional markets are generally less
efficient than developed markets (Magnusson and Wydick 2002;
Smith, et al., 2002; Jefferis and Smith, 2005; Marashdeh,
2005, 2006; Abuzarour, 2005; Simons and Laryea, 2006). This
requires examining the extent to which accounting
information is influential and informative in these markets.
Second, transitional markets are characterized by a
relatively high degree of information asymmetry (Cornelius,
1993; Economic and Social Council. 2004). This requires the
examination of the extent to which the accounting
information helps lessen the overall asymmetry. In this
case, accounting information can play this role if this type
of information is informative enough to the stockholders for
which the shareholder value is considered as the dependent
variable. Accordingly, the major objective of this study is
to explore the extent to which the accounting information
affects the shareholder value measured by the market-to-book
ratio. It is worth to note that the MB ratio is of
significant practical use in transitional stock markets.
Since this ratio compares the market value of a stock to its
book value, it offers, then, a practical criterion on the
extent to which the transitional stock market is developing
and progressing. Therefore, the MB ratio can be adequately
be used in the case of Egypt stock market being considered
in a transitional stage.
Research Questions
The methodology in this paper is
designed to measure the quantitative effect of financial
accounting information in the case of the actively trading
firms in Egypt. The measurement is related to three
shareholder value classes to show the extent to which
accounting information affects each class. Therefore, this
paper is to find answers to the following question: what is
the speed of adjusting shareholder value to a target value
in association with financial accounting information? It is
worth noting that the speed of adjustment shows the extent
to which the financial accounting information is related to
shareholder value. This is quite useful for policy as well
as corporate decisions makers when setting policies for
financial disclosure and ultimately is to be considered as a
basis for a future comparison with other transitional
markets.
The contribution of the paper can
be outlined as follows. First, this study is the first to
address the issue of shareholder value in Egypt as a
transition economy.
Second, contrary to other related studies that address the
shareholder value as a single level, this study
differentiates between three shareholder value classes to
show the extent to which accounting information is
informative. The three classes view is adopted since it was
realized that considerable differences exist between the
three classes. The descriptive statistics of the three MB
classes show that the mean of each class is 5.93, 3.32 and
1.19 for the high, medium and low shareholder value classes
respectively. The standard deviation for each class is also
quite indicative; 6.94, 2.54, and 0.85 for the for the high,
medium and low shareholder value classes respectively. This
indicates that the differences between the three classes are
significant and, therefore, the characteristics of each
class are expected to provide meaningful and distinctive
results. Third, differently from other related studies, this
study examines the informativeness of accounting information
in a dynamic manner utilizing the properties of the partial
adjustment model.
The paper is organized as follows.
Section II discusses the links between and among the
accounting information, stock market characteristics and
shareholder value. Section III describes the research
variables. Section IV discusses the data and methodology of
the study. Section V describes the results and discusses the
analysis respectively. Section VI concludes.
II. Accounting
Information, Stock Market Characteristics and Shareholders
Value
The literature on corporate
financial fundamental analysis is one of the
well-established fields of study in the finance theory
(Graham et al., 1962; Foulke, 1968; Bellemore and Ritchie,
1974; Strong, 2001; Corrado and Jordan, 2002; Li, 2003). The
literature has been trying to examine the interdisciplinary
of three fields of study: financial management, corporate
finance and investments. These fields have always been
related to each other through the two valuation systems: the
public accounting reports and security market (Zellner,
1988; Östermark and Aaltonen, 1995). The common form of
fundamental information is financial ratios that have been
used based on the assumption that they reflect events that
have affected the firm’s operations. These events include
(a) those occurred within the factor input markets and (b)
those occurred within the output markets of the firm. These
events may be specific to a particular industry or maybe
economy-wide events (Gonedes, 1973).
As financial ratios have been used
extensively for corporate financial reporting, it is now a
common understanding that if corporate financial reporting
is to be adequately supportive of investment decision
making, then clearly it must provide information useful to
the formation of risk and return assessment (Farelly et al.,
1985). On the use of fundamental information, Li (2003) used
financial statement information to develop a model of firm’s
long-term earnings growth which provides reliable financial
indicator that distinguishes between high- and low-growth
firms.
This study extends the
relationship between the fundamental analysis and stock
market characteristics to address one more dimension, which
is shareholder value being commonly measured by the
market-to-book ratio. The BM (or alternatively MB) ratio is
one of the fundamentals that have been exposed to an
extensive empirical examination. The BM ratio is the
relationship between the book value of common equity to the
market value of common equity. This relationship is
typically expressed in the form of B/M ratio, rather than
M/B ratio, for some practical reasons. As Beaver and Ryan
(1993) indicate, the book-to-market form is used because the
book value of common equity can take on small values or
negative values. If book value is in the denominator of the
ratio, problems of interpretation arise, while no particular
problems arise if book values appear in the numerator.
Therefore, the indications of B/M ratio, or M/B ratio, are
the same when the book values are not discrete. It is
established in the theory of finance that the BM ratio
reflects the relationship between firm’s historical value of
its assets and the economic value, or market assessment, of
common equity. This ratio has long been recognized as an
indicator to many financial characteristics such as:
(a)
An indicator to expected return on equity being taken as an
association between price to book value (Preinreich, 1932;
Edwards and Bell, 1961; Graham et al., 1962; Peasnell,
1982).
(b)
A growth indicator (Preinreich, 1932; Kay, 1976; Brief and
Lawson, 1992).
(c)
Is determined by leverage (Graham, et al., 1962).
(d)
An indicator to the mispriced stocks (Rosenberg et al.,
1985).
(e)
Explains mean stock returns (Chan et al., 1991; Fama and
French, 1992).
(f)
A tool used in a contrarian investment strategy, e.g., a
‘value investment strategy or value stocks’ versus a
‘glamour investment strategy or glamour stock’ (Lakonishok
et al., 1994).
(g)
A measure of the value created to the shareholder (Shapiro
and Balbirer, 2000).
(h)
A ‘margin of safety’ (Bodie et al., 2003), which indicates
that analysts sometimes consider the stock of a firm with a
low MB ratio to be a “safer” investment, seeing the book
value as a “floor” supporting the market price because the
firm always has the option to liquidate its assets for their
book values. However, this view is questionable because some
firms do sometimes sell for less than book value.
III. Research
Variables and Proxies
Dependent Variable
The dependent variable is the firm’s market-to-book ratio.
This ratio is recognized as a measure of shareholder value.
In this study, the M/B (rather than B/M) ratio is used as
the dependent variable for two reasons: (1) it is a common
measure of the value created to shareholders, and (2) the
data used in this study does not contain negative values
that can cause any interpretation problems.
Independent Variables
Primarily, the independent variables include the financial
ratios as a form of accounting information that
reflects firm’s fundamentals. The literature on the use of
accounting information is extensive and does not
include a consensus of the number, type and measurement of
the financial ratios to be used. Therefore,
through considerably surveying the relevant literature this
study is examining a total of eighty-nine financial
ratios.
The financial ratios examined in this study are chosen on
the basis of what follows.
1- Popularity:
the ratios that are commonly examined in previous studies in
the literature. This also includes the ratios discussed in
the ‘Corporate Finance,’ ‘Financial Management’ and
‘Investment’ textbooks that include financial ratio analysis
as one of the main topics (Foulke, 1968; Myer, 1969;
Johnson, 1971; Soldofsky and Olive, 1974; Bellemore and
Ritchie, 1974; Lev, 1974;Van Horne and Wachowicz, 1995;
Radcliffe, 1997; Emery and Finnerty, 1997; Besley and
Brigham, 2000; Shapiro and Balbirer, 2000; Strong, 2001;
Corrado and Jordan, 2002; Bodie et al., 2003; Fraser and
Ormiston, 2004). This is not an exclusive list of the
financial ratios rather than a list of the most common and
recent texts in the literature. The relevant references are
extensive. For example, Beaver (1966), when choosing the
ratios, examined nineteen financial statement analysis
texts. Beaver (1968) examined up to thirty-six sources
including ten financial statement analysis texts, six
general finance texts, five security analysis texts, eight
journal articles dealing with ratio analysis, four
accounting texts, and three government studies of the use of
the ratios. Courtis (1978) examined ten textbooks in
accounting and finance. In this study, the authors have
added eight textbooks in corporate finance and financial
management.
2- Convenience:
the ratios that are commonly mentioned in (or easily
calculated using) corporate reports and/or financial
analysts reports. The financial ratios commonly discussed in
Financial Management textbooks are also considered a good
basis. This criterion allows examining the extent to which
the on-reach financial ratios reflect corporate fundamentals
and, therefore, affect investors behavior
3- Scope:
the financial ratios are basically corporate rather than
industry ratios.
4- Availability:
the financial ratios are available for all firms included in
the study for seven years. It is worth noting that number of
the asset utilization ratios and dividends-based ratios are
not included in the examined ratios due to (a) the
unavailability of relevant asset utilization data, and (b)
the firms included in the sample suffer from disruptions in
dividends payments.
IV. Data
and Methodology
Data
The data used in this study are
obtained from Kompass Egypt Financial Year Book (Fiani
& Partners) and the stock market publications in Egypt. The
data cover the six years 1998-2003. The total number of
firms included in the study is 99 non-financial firms. Firms
were selected based on two criteria. First, the
non-financial firms amongst the 100 actively trading firms
in Egypt stock market. Second, the non-financial firms
amongst the 100 firms with the highest market value.
The firms included in the study
were then divided into three groups: firms with high,
medium, and low MB ratio respectively. For each firm, the
average MB for seven years was calculated. Firms’ average
MBs (scaled by the growth rate of MB for seven years) were
arranged in a descending order, then, the sum of all was
divided by three (this is to produce three classes).
Starting from the first firm with the highest MB, the first
group of firms was chosen whose sum of MB equal to the sum
of MB divided by three. So were the second and the third
groups chosen. As a result, the first group with the highest
MB includes twenty-one firms, the second group with the
medium MB includes twenty-two firms, and the third group
includes fifty-six firms. The descriptive statistics of the
ratios included in this study are shown in table (A) in the
appendix.
Methodology
(a) Estimation:
The methodology examines the effects of the accounting
information (financial ratios) on the firm’s MB ratios that
are classified into three levels: High, medium and low MB.
The properties of the partial adjustment models capture the
effects under consideration. The estimating equation of the
partial adjustment autoregressive model takes the form that
follows. A more detailed discussion about the structures of
partial adjustment models is further explained in Kennedy
(1998, pp.143-156) and Greene (2000, pp.720-724).
The usefulness of studying the effects of accounting
information is met by the properties of the partial
adjustment model. That is, in general, sometimes the
economic theory specifies that the desired rather
than the actual value of the dependent variable is
determined by the independent variables(s). But,
this relationship cannot be estimated directly
because the desired level of the dependent variable
is unknown. This dilemma is usually resolved by
specifying that the actual value of the dependent
variable adjusts or is adjusted to the desired level
according to some simple rule. In the partial
adjustment models, the actual value adjusts by some
constant fraction of the difference between the
actual and desired values (Kennedy, 1998). The
partial adjustment formulation offers a number of
significant practical advantages (Greene, 2000) that
(1) It is intrinsically linear in the parameters
(unrestricted), and (2) its disturbance is non-autocorrelated
if the error term
 was
to begin with. As such, the parameters of this model
can be estimated consistently and efficiently by
ordinary least squares in regression equations.
(b) Sensitivity Analysis (Robustness of the
Estimates):
In the literature of fundamental
analysis, selective reporting is highly likely given
the very large number of potential regressors. For
this, Extreme Bound Analysis (EBA) avoids the
pitfalls of selective reporting by directly
incorporating prior information and following a
systematic approach to testing the fragility of
coefficient estimates. As indicated by Leamer (1983,
1985), Leamer and Leonard (1983) and Levine and
Renelt (1992), the EBA uses equation that takes the
form
II. Results
and Discussion
Table (1) shows the results of regressing the
fundamental financial ratios against MB ratios (as a
proxy fro the shareholder value). The results are
divided into two parts. Part (a) discusses the
estimates of the regression coefficients and part
(b) discusses the robustness (the sensitivity
analysis) of the estimates.
(a) Estimates of the Stepwise Regression
Coefficients:
Table 1 shows the significant accounting information
contained in the financial ratios and their
association with the three shareholder value
classes. The financial ratios are classified into
the common five categories. This aims at showing the
type of accounting information that contributes the
most to shareholder value classes.
Regarding the speed of adjustment
 ,
the results show that the financial ratios help
adjust shareholder value to a target level. This is
true since all coefficients of
 are
positive and statistically significant. This is
considered one of the fundamental results of this
study since it is obvious that shareholder value is
positively associated with accounting information.
The values of the coefficients of the speed of
adjustments are quite important. In the high
shareholder value class, the financial ratios help
adjust high shareholder value to the target value at
a speed of 0.5263, the next is the low shareholder
value which adjusts at a speed of 0.2813, and then
the medium shareholder value which adjusts at a
speed of 0.2255. This indicates that the accounting
information contained in the financial ratios
contribute the most to the high, the low, and the
medium shareholder value respectively. It is worth
noting that the speed of adjustments in the medium
and low classes are very close to each other (0.2255
and 0.2813 respectively). This could be explained
that shareholders in these two classes utilize the
financial ratios, hence, accounting information, by
the same manner relatively.
The results also show that
shareholder value classes are associated with
certain categories of financial ratios. The high
shareholder value class is positively associated
with two categories: assets efficiency and
profitability. The medium shareholder value is
associated with three categories: solvency, asset
efficiency and profitability. The low shareholder
value is associated with the five financial
categories. The signs of the estimates in the medium
and low classes are quite informative as well. In
the medium class, the negative coefficient of cash
and receivables/expenditures (CRTE) indicates that
high liquidity is not appreciated by the
shareholders. The same is true for the negative
coefficient of accounts payable turnover (APT).
Since the latter ratio is calculated as cost of
goods sold/accounts payables, the negative sign
indicates that the shareholders do not appreciate
the high cost elements especially the cost of goods
sold. The positive signs of assets annual growth and
profitability ratios indicate that these two items
contribute to shareholder value positively. In this
case, a quite similarity exists between the high and
medium shareholder value classes. The results also
show that the Gas, Oil & Mining Industries is
associated with a decreasing shareholder value in
the medium class.
In the low shareholder value
class, the negative estimates of the fixed assets
turnover (FAT) and working capital/cash flow (WCCF)
indicate that shareholder in this class do not
appreciate the operational roles of sales, fixed
assets and working capital. This is why these firms
are associated with low shareholder value. On the
other hand, the negative coefficient of
inventory/current assets (InvCA) has a similar
implication as in the medium class that shareholders
do not appreciate firms’ liquidity. The negative
coefficient of cost of sales/sales (COGSS) also has
a similar implication as in the medium class that
shareholders do not appreciate cost elements.
Regarding the leverage ratios, the negative
coefficient of current liabilities/working capital (CLWC)
indicates that shareholders in this class do not
appreciate the benefits of costless financing such
as current liabilities. Nevertheless, the positive
coefficient of short-term debt financing (STDR)
indicates that shareholder favor short-term debt
financing rather than long-term debt. This also
shows that the viable financing source is the
short-term debt. The estimates of profitability
ratios show the operational and investment trends in
the low shareholder value class. That is, the
positive coefficient of market value added (MVA) and
growth of EBIT per share (GEBIT) indicate that
shareholders are interested in the value of their
investments and in the firms’ operational prospect
such as the growth of earnings before interest and
tax. On the other hand, the negative coefficients of
retained earnings ratio (REA) and stock return (SR)
provide evidence on that claim. That is,
shareholders in the low class do not prefer retained
earnings and, at the same time, a decreasing stock
return is associated with low shareholder value.
Regarding the firm-specific
variable, the positive coefficient of the size dummy
in the low shareholder value class shows that large
size firms are associated with low shareholder
value. This result meets the general trend observed
in Egypt stock market which has been suffering from
decreasing market value and market capitalization
during the period of this study. As for the industry
type, three industries (Agriculture & Fisheries,
Food & Beverages, Mills & Storages Industries) are
associated with the low shareholder value and
another three industries (Chemicals & Fertilizers,
Engineering & Electrical, Utilities & Services
Industries) are associated with a decreasing
shareholder value.
(b) Robustness of the Estimates
(Sensitivity Analysis)
The sensitivity analysis focuses
on the variables that refer to the speed of
adjusting shareholder value
[]
to a target level [ ]
in the partial adjustment model. These variables
show the extent to which shareholder value adjusts
to a target level according to the content of
accounting information contained in the financial
ratios. Table (2) includes the results of the
sensitivity analysis.
The results of sensitivity
analysis show a considerable degree of consistency.
The estimates of the speed of adjusting
shareholder
value are robust at the three shareholder value
classes. This means that the estimates of speed of
adjustment will not vary (stable) according to the
variations in firms’ five categories of financial
performance. That is, the accounting information is
quite informative to all shareholder value classes.
A sensitivity analysis is also
carried out to the firm-specific variables. This is
to add more robustness to the results. Two reasons
for doing this further analysis are outlined. First,
from a methodology point of view, the firm-specific
variables are used to show the extent to which firms
characteristics can influence the results. That is,
whether the results are affected by factors other
than the variables under consideration. Second,
according to the methodology of this paper, it is
quite informative to see whether firm-specific
variables are associated with shareholder value
classes robustly.
The results in table (3) also show that the
firm-specific variables (which appear in the medium
and low shareholder value classes only) are robust.
This means that those firms’ characteristics are
quite stable and will not affect the speed of
adjusting shareholder value in the medium and low
classes.
II. Conclusion
This study attempts to quantify
the informativeness of financial accounting
information (contained in the financial ratios) in
association with three shareholder value classes. In
general, the results show that the financial
accounting information plays a significant role to
the high and medium shareholder value classes since
shareholders in these classes appear to be
interested in the growth of total assets and
profitability, which is an indicator of long-term
prosperity. Nevertheless, the accounting financial
information plays a limited role to the low
shareholder value class. That is, shareholders in
latter class appear to be interested in firm’s
liquidity and leverage levels rather than long-term
growth and profitability. In addition, it is worth
to note that the responses of the shareholders in
the high and medium classes are converging
relatively to the extent that the results of these
two classes can be regarded jointly as if they
belong to one class. This does not mean that the
classification of shareholder value into three
classes beforehand was not justified. Unless the
three classes’ classification was not attempted, we
would no have reached this conclusion regarding the
responses of shareholders in the low class in
comparison with those in the high and medium
classes.
Regarding the use of the ‘Partial Adjustment Model,’
it is worth noting that this technique (along with
the three classes’ classification) turned out useful
in finding out the diversion in shareholders
interests and responses. Therefore, this technique
is quite relevant to the nature and purpose of this
study. Taking into account that the first order of
the dependent variable (Yi,t-1 and Yi,t)
is examined, the period of six years, although
not optimal (from a theoretical point of view), but
can be considered quite adequate to produce
meaningful results.
In this regard, the diversion is shareholders
interest and responses leads to the realized
considerable instability in the Egyptian stock
market and, eventually, contributes to the market
inefficiency. This is evidenced by other previously
mentioned studies of stock market inefficiency in
Egypt. In addition, the results show that
firm-specific variables (size and industry type) do
matter to the low shareholder value class
relatively. This adds to the informativeness of the
accounting information since it is observed and well
known that most of the industries in transitional
market in general, and in Egypt, in particular, are
associated with low shareholder value due to
elements of market inefficiency. This conclusion is
supported by the results of the sensitivity analysis
of the firm-specific variables where all estimates
are found robust.
Policy Implications
On the policy level, the issue of
financial accounting informativeness is to be
related to the issue of financial disclosure. That
is, the findings of this study suggest that
financial disclosure is to focus of the firms’
growth prospects and profitability. These two
factors are found highly significant to the high and
medium shareholder value classes. In addition,
policy-wise, financial reporting is to play an
effective role by narrowing the low shareholder
value class and expanding the high and medium
classes. The release and analysis of firms’ growth
and profitability related financial information can
help reach and improve this objective substantially.
In addition, since financial ratios, and generally,
financial information are known to affect
shareholders decision, the findings of this study
show that the release of firms’ growth and
profitability information is highly supported by
shareholders.
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