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The Impact of Accounting Information on Share Prices: A Study of

Listed Companies in Sri Lanka

Article · July 2016

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 The Impact of Accounting Information on Share Prices: A
Study of Listed Companies in Sri Lanka

Sarifudeen. A.L.
Department of Accountancy and Finance,
Faculty of Management and Commerce,
South Eastern University of Sri Lanka
University Park, Oluvil
[email protected]

Abstract

The stock price of securities is one of the most important variables for valuation. Managers
are looking for information that can assist them in predicting stock prices. This enables
managers to develop dimensions that better decisions based on accurate information on
financial variables can make the necessary. The main objective of this study is to explore the
relationship between equity price with earnings, dividends and net asset. The present study
examines the impact of Earning per share,(EPS) Dividend per share (DPS) and Net assets
value per share (NAVPS) in the formulation of stock prices on a sample of 65 companies
listed on the price in Colombo Stock Exchange (CSE) during the 2010-2014 period. The
resulting evidence suggests that the joint explanatory power of the above parameters in the
formation of stock prices increases over time. Earnings are the most widely used accounting
information for investment decisions in Sri Lanka, followed by dividends and net book value.
Therefore, the study suggests that companies should improve the quality of earnings as
manipulated earnings (of which Dividends are sub-sets) have significant effects on share
prices.

Keywords: Accounting information, Stock prices, Stock returns, Dividend per share,
Book value,

Introduction

Capital markets are considered as one of the most important economic sectors of countries.
Economic decision making requires comprehensive and timely available information that
helps them to be the optimal way of allocating resources that the capital market is responsible
for this important. The stock price is one of the most important variables for valuation of
securities. On the one hand investment development Attract efficient capital and led them to
the productive sectors of the economy and the other hand, orientation of investors (based on

1
risk and returns), will be led investments in industries that have benefit and This will result in
resource allocation (Jones,2005).

Historically, market data have always conquered over accounting data when it comes to
identifying the factors that affect stock prices. In the recent years, an increasing number of
empirical studies indicate that the financial statements of entities certain parameters that play a
critical role in the course of their respective equities in the stock market.

The scope of this study is to examine the effect of the accounting information on the Colombo
Stock Exchange (CSE), by analyzing data extracted from the financial statements of a sample
of CSE listed companies.

Statement of the problem

The stock market has become popular subject among the public especially among investors as
well as academic researchers. Particularly they are concern about the predictability of share
prices and the variable related to it. Financial analysis is the process of determining the
significant operating and financial characteristics of a firm from accounting data and financial
statements. The Financial statements contain a wealth of information, which, if properly
analyzed and interpreted can provide valuable insights into a firm’s performance. These
statements provide investors with essential information to evaluate their investments
decisions. Therefore, this research studies carried out to investigate the impact and
relationship between financial information content in annual report and share prices of listed
shares in Sri Lanka.

Research Question

Whether a listed company’s accounting information is useful to explain its market value, in
the context of share market in Sri Lanka?

Research Objectives

1) To investigate the dynamic relationship between accounting numbers and market

values of listed companies on the Colombo Stock Exchange.

2) To analyze the ability of accounting information to affect share prices of firms listed
on the Colombo Stock Exchange;

Literature Review

By reviewing the previous researches, there are number of evidence on the importance of
financial information and their value relevance is publicly available. Among them different
studies have paid attention on different ways like value relevance of earnings, value relevance
of net asset ,value relevance of dividend and the overall value relevance of accounting and
non-accounting variables.

2
Value relevance is defined in the extant literature as the association between accounting
variables and equity market values. Although the literature examining such associations
extends back at least 30 years (miller and Modigliani, 1966) the first study of which are aware
that uses the term “value relevance” to describe this association is amir, harris and venuti
(1993). Beaver (1999) and barth (2000) provide formal definitions that are closely related to
above. The key commonality in the definitions is that accounting variables are estimated value
relevant if it has a significant association with equity market value.

Stock price changes are often used to explain the accounting data referred to in the relevant
literature. Perera and Thrikawala (2010) have revealed statistically relationship between
Accounting Information and Market Price per Share. This study finds that investors use
accounting information for making their investment decisions. Karunarathne and Rajapakse
(2010) reported that the value relevance of accounting information is more value relevant
under the Price model than under the Return Model.

Collins, Maydew and Weiss (1997) have revealed that the joint explanatory power of earnings
and book values has not declined in the last forty years. To the contrary, they stated that their
explanatory power has increased in the same period. This conclusion is reached by several
other authors as Barth, Beaver and Landsman (1998) and Keener (2011, while Burgstahler and
Dichev (1997) suggested that the function which defines the relationship between stock prices
and earnings and book values is convex. Also, Holthausen and Watts (2001) and Negakis
(2005), after reviewing the relevant literature, concluded that earnings and book values do not
affect in the same manner stock prices. Other studies (Hirschey et al., 2001; Aaker and
Jacobson, 2001; Graham et al., 2002; Al-Harbi, 2003; Liang and Yao, 2005; Junttila et al.,
2005; Tan and Lim 2007), have identified a variety of relationships between the above
parameters. Vijitha and Nimalathasan (2014) revealed that accounting variables have
significantly explanatory power over share price. And also a number of researchers have
provided evidence that the effect of earnings and book values on stock prices is different for
different industries (Hughes, 2000; Boone, 2002; Riley et al., 2003; Zhao, 2010) or different
countries (Filip and Raffournier, 2010; Alsaman, 2003; Martinez, 2003; Habib, 2004; Junttila
et al. 2005; Goodwin and Ahmed, 2006; Ibrahim et al., 2009; Bo, 2009). Chandrapala (2013)
reported that the value relevance of earnings and book value is below average and the value
relevance of accounting information of firms with ownership concentration is higher than that
of ownership non-concentrated firms.

Chandrapala (2010) found that EPS, BVPS and ROE have positive relationship on market
value of securities. Chandra and Ro (2008) found that the value relevance of earnings and
revenues remained constant over time, while Jenkings, Kane and Velury (2009) have proved
that future business expectations kept value relevance of earning high. Canibao, Garcia-Ayuso
and Rueda (1999) examined accounting data taken from Spanish companies, showing that the
joint explanatory power of earnings and book values has not declined in the latest decades.
However, their results demonstrated a slight decline in the marginal explanatory power of
book values in relation to earnings. Musthafa and Jahfer (2013) revealed that book value per
share (BVPS), earrings per share (EPS) and operating cash flow per share (OCFPS) have a
positive and statistically significant relationship with market value per share (MVPS).
Tharmila and Nimalathasan (2013) found that earning per share EPS and net assets value per
share NAVPS have significantly positive relationship with market price per share (MPPS).

3
Methodology

This study reflects the relevance of earnings, dividends, and net asset value and their
contribution for explaining share price with the Ohlson (1995) model with respect to listed
companies in Sri Lanka.

Conceptual framework

Based on the Ohlson (1995) model, the conceptual framework of this study has been derived
(see figure 1) this would also help the study to explore the relationship of accounting variables
to equity price of a firm’s shares. Thus the present study uses the model that includes all of
the main financial statement measures as follows (Fig. 1):

Net asset value per share

Earnings per share Share Price

Dividend per share

Figure1 : Conceptual model of value relevance

There are three independent variables (Earnings, Dividend and Net asset) and they have been
measured on per share basis.

Equity price is considered as a dependent variable and it is in simple term the market price of
particular company’s shares at a particular time.

Hypotheses
Based on the conceptual framework, the following hypotheses are developed in order to
achieve the aim of this study.

H1: There is positive relationship between net asset value and market value of equity.
H2: There is positive relationship between earnings and market value of equity.
H3: There is positive relationship between dividend and market value of equity.

4
Operationalization

This study considers market value of equity as the dependent variable and earnings, dividends
and net assets are as the independent variables on per share basis. The operationalization is
also considered in the same context. (See table 1)

Table 1 Operationalization of the study

Dependent(explained) Independent Indicators to measure the
variable (explanatory) variables variable
Net asset value per share Total net asset & No. of shares
Share price market Earnings per share Net earnings & No. of shares
value per share) Dividend per share Gross dividend & No. of shares
(Source: operationalization for this study based on the Ohlson (1995) model)

Model of the Study

Basically, the Ohlson (1995) model considers the relationship between accounting numbers
and equity price of a firm for measuring its market value. Some studies have reformulated the
ohlson (1995)model to explore the relevance accounting numbers with different contexts(e.g.;
Senthil nathan 2009a;brief and zarowin 1999;hand and landsman 2005;ota 2001).most studies
consider the Ohlson (1995) model as the key and appropriate model for examining the value
relevance of accounting variables and other information.in the same context, this study also
reformulates the ohlson (1995) model and attempts to examine the relevance of net asset value
,earnings and dividends as content values in the equity price, at time t, as implied in Ohlson
(1995).

Basic and simplest form of ohlson’s (1995) model is

= + v2 (1)
Where,

= Equity share price at time t,

= Book value at time t,
= Parameter of autoregressive process of earnings,
= Abnormal earnings per share at time t,
= parameter of other earnings related information and
V2 = Other earnings related information at time t.

This study empirically evaluates the data with regression analysis by employing the above
reformulated equation (1).hence, the empirical linear regression model of this study is:

MVPStn=ß 0+ß1EPSit+ß2DPSit+ß3BVPSit+εit (2)

Where,

5
LDSP = Last Day Price per share
VRDPS = Dividends per Share
VRBVPS = Book value per share
VREPS = Earnings per Share
t = Time dimension
i = Individual firm

Sample and data collection

The paper obtains all necessary data from the Colombo Stock exchange. These data sets span
the 5 year period from 2010 to 2014. The sample is consisting of companies listed in Colombo
Stock Exchange representing food & beverage, tobacco, manufacturing, plantation, land &
property and chemicals & pharmaceutical. These industries are considered as largest sectors
since these sectors representing higher number of companies and also these sectors would
contribute significantly to the economy. Bank, Finance & Insurance sector is excluded from
the sample even it is a largest sector in Sri Lanka. Thus the accounting practices for the
financial companies are different from other companies.

Data analysis and presentation

Descriptive statistics

This study attempts to measure the relevance of accounting variables for explaining the
contemporaneous equity price. On per share basis, net assets, earnings and dividends are
considered as the independent variables and equity price as the dependent variable.
Descriptive results indicate that the value of net assets ranges between 1.98 and 1613.6 with a
mean value 1.15 and standard deviation 219.63. Similarly, the results indicate that earnings
have the range 0.04 and 368.4 with the mean value and standard deviation as 16.44 and 38.71,
respectively. Dividends have dispersed within 0.1 as minimum to 65 as maximum with the
mean 4.87 and standard deviation 8.6. Comparatively, the coefficients of variance of the
independent variable indicate that there is lower dispersion of dividends than other
independent variables, comparatively. The descriptive results indicate that equity price ranges
from 0.22 as minimum to 15000 as maximum with the mean value 3 and standard deviation
1146. The descriptive statistics indicate high dispersion of data for every variable in this
study, thus questioning the usefulness of the data.

Table 2 Descriptive Statistics of the variables

N Minimum Maximum Mean Std. Deviation
EPS 210 .04 368.40 16.4394 38.70524
DPS 210 .10 65.00 4.8678 8.58309
NAVPS 210 1.98 1613.60 1.1538E2 219.62682
MVPS 210 .22 15000.00 2.9970E2 1145.76374

6
Correlation Analysis

Correlation between Equity Price and Net Assets

The correlation analysis reveals that there is positive significant relationship between net
assets and the equity price (R = 0.776, p < 0.01), thus implying that net assets as the
independent variable have explanatory power for explaining the contemporary equity price.
Barkham and Ward (1999) and Liow (2003) explores the usefulness of net assets value as a
factor in determining a firm value in property development business, thus implying a positive
correlation between net assets value and equity price. Consistently, our results also spell the
same as positive relationship of net assets value to equity price.

Table 3 Result of Correlation between Variables

EPS DPS NAVPS MVPS

EPS Pearson Correlation 1

Sig. (2-tailed)

N 210
DPS Pearson Correlation .527** 1
Sig. (2-tailed) .000

N 210 210
NAVPS Pearson Correlation .721** .584** 1
Sig. (2-tailed) .000 .000

N 210 210 210

MVPS Pearson Correlation .388** .266** .776** 1
Sig. (2-tailed) .000 .000 .000

N 210 210 210 210

** Correlation is significant at the 0.01 level (2-tailed).

* Correlation is significant at the 0.05 level (2-tailed).

Correlation between Equity Price and Earnings

Similarly, earnings also have a positive significant correlation with the equity price (R =
0.388, p < 0.01). Many studies endorse that there is a positive relationship between non-
negative earnings and equity price (e.g., Senthil Nathan, 2009c; Alfaraih and Alanezi, 2011;
Graham and King, 2000; Karunaratne and Rajapaksa, 2010).

Alfaraih and Alanezi (2011) also evaluate correlation coefficient for the relationship between
earnings and equity price. This study reveals that earnings and equity price have positive
significant correlation (R = 0.71, p < 0.05) at the 5% level and our study also consistently
reports such a significant relationship between earnings and equity prices. Further,
Karunaratne and Rajapaksa (2010) also indicates that there is positive significant correlation
between earnings and equity price (R = 0.590, p < 0.01) in relation to the firms in Sri Lanka.
7
Notably, our correlation results (R =0.388, p < 0.01) for the relationship between earnings and
equity price are also very close and supportively consistent with their study

Correlation between Equity Price and Dividends

The results indicate that dividends also have a positive significant coefficient for explaining
the equity price (R = 0.266, p < 0.01). According to Ohlson (1995), the model endorses
negative relationship between dividends and equity price (see equation (3.14) in Chapter 3).
The positive significant correlation coefficient (R = 0.266, p < 0.01) between dividends and
equity price in this study is not consistent with Ohlson's (1995) specification. However, the
dividends declaration would take place after the forming of the fiscal yearend equity price.
Hence, dividends in this study possibly explore a positive relationship with equity price, since
the dividends declared (after the formation of fiscal yearend equity price) might have been
representing the information as the proxy for expected dividends that has been incorporated in
the yearend equity price.

Overall results of the correlation coefficients between independent and dependent variables
have meaningful significant relationship. It simplifies that accounting variables of net assets,
earnings and dividends have individual explanatory power for explaining contemporaneous
equity price.

Regression Analysis
Regression analysis shows how to determine nature of relationship between two or more
variables. The known variables are called the independent variables. The variable that is to be
predicted is the dependent variable.

Table 4 Model Summary

Model R R Square Adjusted R Square Std. Error of the Estimate
a
1 .835 .698 .693 634.45801
a. Predictors: (Constant), NAVPS, DPS, EPS

The Model summary (table 4) shows the impact of independent variable and dependent
variable. According to that Adjusted R square is 0.698. It means that there is 69.8 % of the
impact of the independent variable on the dependent variable. It indicates that value relevance
of accounting information has 69.8% impact on stock price.

Table 5 Coefficients Summery

Model Unstandardized Coefficients Standardized t Sig.
Coefficients
B Std. Error Beta
1 (Constant) -80.969 51.445 -1.574 .117

EPS -8.999 1.666 -.304 -5.402 .000

DPS -31.426 6.413 -.235 -4.900 .000
NAVPS 5.908 .307 1.132 19.216 .000
a. Dependent Variable: MVPS

8
This linear regression equation shows that β equals to -8.999, -31.426, and 5.908. That means
slop of the regression line, which simply indicates that there is a positive relationship between
the EPS and DPS, NAVPS. DPS has a significant positive relationship with stock price (p
(0.000) < 0.05). NAVPS also has a significant positive relationship with stock price (p (0.000)
< 0.05) and also EPS has the positive relationship with stock price at 5% significant level (p
(0.000) < 0.05). The value of “α” (Constant Value) is -80.969.

Hypothesis Testing

H1: There is a significant relationship between NAVPS and stock price

According to the result of correlation analysis refers in the Table 3; there is a strong positive
relationship between Net asset value per share and stock price at 1% significant level. Its p
value (0.000) is less than 0.001. Hence the researcher rejects the null hypothesis (H0) and
accepts H1.

Table 6 Summary of the Hypothesis Testing

No Hypothesis Results Tools
H1 There is a significant relationship between Accepted Regression /
EPS and the stock price Correlation
H2 There is a significant relationship between Accepted Regression /
DPS and the stock price. Correlation

H3 There is a significant relationship between Accepted Regression /

NAVPS and the stock price. Correlation

H2: There is a significant relationship between EPS and the stock price
According to the result of correlation analysis refers in the Table 3; there is a strong positive
relationship between Earning per share and stock price at 1% significant level. Its p value
(0.000) is less than 0.001. Hence the researcher rejects the null hypothesis (H0) and accepts
H2.

H3: There is a significant relationship between DPS and the Stock price.
According to the result of correlation analysis refers in the Table 3; there is a strong positive
relationship between Dividend per share and Stock price at 1% significant level. Its p value
(0.000) is less than 0.001. Hence the researcher rejects the null hypothesis (H0) and accepts
H3.
Conclusion and Recommendations
This study compares the incremental value relevance of net assets, earnings and dividends for
explaining the contemporaneous equity price in Sri Lankan share market. In this study,
reformulated incremental value relevance model has been used to explain the equity price in
Sri Lankan share market by employing the Ohlson (1995) model. Hence, this study attempts
to associate the accounting variables with equity price to evaluate the correlation coefficient
and regression results for examine the impact of accounting information on share prices in Sri
Lanka share market. Especially, sixty five companies have been tested for a five years period
from 2010 to 2014.

9
The correlation coefficient results suggest that there is a positive significant value relevance of
net assets, earnings and dividends for explaining the equity price. This indicates that the
independent variables have explanatory power for explaining the contemporaneous equity
price at the significant level. Overall results of the correlation coefficients between
independent and dependent variables have meaningful significant relationship. It simplifies
that the accounting variables of net assets, earnings and dividends have individual explanatory
power for explaining contemporaneous equity price.

The regression pooled, fixed-year, and fixed-sector results reveal that there is a positive
significant incremental value relevance of net assets, earnings and dividends to explain the
equity price at the 1% level. However, the regression results of individual accounting
variables do not reveal sufficient information for valuing a firm. Comparatively, this result
reveals inconsistent relationship between dependent and

In this study, the relevance of dividends is explored, since the dividends are proposed after the
fiscal year end; and the information of dividends to be proposed (not the contemporaneous
earnings information) would have acted as the proxy for future earnings by the end of each
fiscal year. Hence, the dividends reveal positive significant incremental relevance, beyond
earnings. This is inconsistent with the assumption of Ohlson (1995) model, Miller and
Modigliani (1961). And also the same inconsistency prevails in the particular reformulation of
Ohlson (1995) model of this study (insisting negative relationship of dividends with equity
price), that current earnings can be the proxy for future earnings, since this study reveals that
dividends, instead of current earnings, act as the proxy for future earnings.

Generally, the Ohlson (1995) model incorporates accounting variables to explain the
contemporaneous equity price. This Ohlson (1995) model and related with reformulated
model (e.g., Senthil nathan 2009b; Fama, 1970; Kothari, 2001; and Nilssion, 2003) explain
that if the stock market is not efficient, financial statements are not useful and they do not
provide information as enough as possible in valuing a firm. Hence, these studies suggest that
no fundamental analysis is useful, if the market is inefficient. According to these arguments,
this study confirms that this study's inconsistent results do not play major role for valuing a
firm which implies that the Sri Lankan share market accounting information are not useful to
explain the contemporaneous equity price and it leads to the inefficiency of Sri Lankan share
market.

This study attempts to suggest that there are some possibilities of market efficiency for
developing the Sri Lanka share market: the firm should disclose the relevant accounting
information; they should provide sufficient financial information to the investors to make
better decision for their investment; misstatement and error of financial information should be
kept away from the financial disclose. It implies that the financial statement should be
prepared clearly through the Sri Lanka Financial Reporting Standards.

In this context, this study also attempts to point out the usefulness of accounting information
for valuing a firm and assisting the inefficient sectors in getting the proper way of using the
accounting information, educating how to handle and direct the accounting variables with
proper profit-oriented systems. Furthermore, this study urges the investors in deciding the
investment dictions. Final decision in their investment towards successful investing ways for
their natural sustainability in their field based on usefulness of accounting information.

10
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