The relationship between excess returns, firm size and earnings on the Johannesburg Stock Exchange

Michael J Page,Francis Palmer

doi:10.4102/sajbm.v22i3.900

Michael J Page, Francis Palmer

Open Access

https://doi.org/10.4102/sajbm.v22i3.900

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Abstract

While considerable empirical work has been conducted in the United States concerning excess returns and the relationship of these returns to firm size and E/P ratio, thus far, there have been few similar empirical studies conducted using Johannesburg Stock Exchange (JSE) data. Evidence of firm size or E/P ratio effects has been ascribed by various authors to either model misspecification or market inefficiencies. In this article the evidence is examined for the South African market using 1370 company years of data over the period 1978 to 1988, and a significant earnings effect is found, but no size effect. In the analysis the problem of data bias is considered with particular emphasis on thin trading issues, and a methodology for future empirical work is described. Finally, it is suggested that the evidence can be better explained by market inefficiencies than model misspecification.

Highlights

Over the last decade there has been intense debate in the United States concerning excess market returns and whether these returns are related to firm size and E/P ratio
Basu adjusted Reinganum's methodology to better account for systematic risk. His findings support those of Reinganum (1981a; 1981b) and Banz (1981) with respect to the size effect Basu did not concur with the results found by Reinganum concerning the E/P effect Basu showed that on average the high E/P ratio securities outperformed those of low E/P firms and that the E/P effect is
As stated in the methodology, these results are based on the period 1978 to 1988 using the within groups ranking procedure; ranking first by F/P ratio and by market value

Summary

Introduction

Over the last decade there has been intense debate in the United States concerning excess market returns and whether these returns are related to firm size and E/P ratio. The existence of excess returns has prompted some researchers to suggest that either the CAPM is misspecified or that the market is inefficient (Reinganum, 1981a: 20; Banz, 1981; Basu, 1983). Other researchers are not convinced and suggest that excess returns have been found as a result of data biases (Roll, 1981: 882; Banz and Breen, 1986: 791). A complicating factor for empirical research undertaken using JSE data is that many of the shares trade infrequently. The beta coefficient of thinly traded firms tends to be underestimated causing artificially inflated returns. Particular attention has been given to minimising the serial correlation effect, caused by thin trading, and other data biases. The methodology that has been used is described in detail in the third section

Methods

Results

Discussion

Conclusion