The Effect of Macroeconomic Changes on the Value Relevance of Accounting Information: The Case of Mexico and the 1995 Financial Crisis

Abstract

Lev and Zarowin (1999) argue that the there has been a decline in the usefulness of financial information in the U.S. resulting from the inability of the current financial reporting system to contemporaneously capture changes in firms' operations and economic conditions. As a result, it appears that accounting information in the U.S. is not as timely as it could be. Francis and Schipper (1999) suggest that the emphasis on objectivity and verifiability, which constrains the early recognition of certain future economic benefits, is one reason U.S. financial statements lack timeliness. The purpose of this research is to examine the value relevance of accounting information in a setting where changes in general price levels and specific asset prices are recognized periodically in the financial statements. Essentially, we investigate whether accounting is more value relevant when it includes more relevant information. Additionally, we examine whether the market's valuation of earnings and book values in this setting is affected by an economic shock since continuous improvement of historical financial data (i.e., restatement) should improve investors' decisions (Lev and Zarowin 1999). Using a sample of Mexican firms traded on the Mexican Stock Exchange (Bolsa) during the period 1992-1997, we investigate the relation between the firms' stock prices and their book values, earnings, and cash flows, taking into account the effect of the 1995 Mexican financial crisis. In pooled cross-sectional tests, we find that book values retain their significance and explanatory power during the crisis while earnings do not. Additionally, the value relevance of book values does not significantly change during the crisis period while the value relevance and the explanatory power of earnings decline during the crisis period. The decline in the valuation of earnings and its explanatory power, however, is attributable to the presence of negative earnings. We attribute the lack of significant changes in the value relevance and explanatory power of book values to the use of replacement costs and price level accounting in Mexico. Finally, in additional analyses we find that the incremental value relevance of two components of Mexican earnings, monetary gains and losses and exchange gains and losses, does not change during the crisis implying that these features of Mexican accounting contribute to its continued relevance during the crisis.