Abstract
This article investigates the value-relevance of earnings and financial analysts’ fundamental signals, as identified by prior research. We document four primary findings. First, consistent with the claims in the accounting literature, the value-relevance of ‘bottom line’ earnings has declined over time. Second, the combined value-relevance of earnings and financial analysts’ fundamental signals have also declined over time. Prior studies in this line of research have generated mixed evidence. In other words, some previous studies support an increase and some others find a decrease in the value-relevance of book values of net assets (common equity) over time. This study focuses on the financial analysts’ fundamental signals, not the book values of net assets, and the change in the degree of the value-relevance of those signals over time. Third, we find a negative correlation between firms’ excess returns and regulations, such as Sarbanes-Oxley (SOX) and Dodd-Frank, which are consistent with the claims of some prior studies that the implementation costs of the regulations may exceed their benefits for shareholders of the corporations affected by the regulations. Finally, we also report that the levels of opportunistic earnings management, reflected in some of those fundamental signals, have declined following these regulations.
Highlights
The purpose of this study is three-pronged: 1) to examine whether the value-relevance of both earnings and the financial analysts‟ fundamental signals has decreased over time; 2) to investigate whether financial regulations, such as the Sarbanes-Oxley Act (SOX) and the Dodd-Frank Wall Street Reform and Consumer Protection Act (Dodd-Frank), have negatively affected firms‟ excess returns; and 3) to evaluate whether the levels of opportunistic earnings management has decreased following these regulations[4].Prior research has focused on fundamental analyses aimed at determining the value of corporate securities through a careful examination of key value-drivers, such as earnings, risk, growth, and competitive position
Using the financial analysts‟ fundamental signals, as identified in Lev and Thiagarajan, along with unexpected earnings data, we posit and document that the value-relevance of both earnings and other financial information contained in those signals have decreased, and the levels of earnings manipulation reflected in some fundamental signal variables have decreased after such financial regulations as the SOX and Dodd-Frank
These results are consistent with the views that financial statement information is of limited use in the valuation of firms in this digital era, and financial regulations have altered the financial reporting environment that results in a decrease in financial flexibility in financial reporting, and an ensuing decrease in opportunistic earnings management
Summary
The purpose of this study is three-pronged: 1) to examine whether the value-relevance of both earnings and the financial analysts‟ fundamental signals (financial information other than earnings) has decreased over time; 2) to investigate whether financial regulations, such as the Sarbanes-Oxley Act (SOX) and the Dodd-Frank Wall Street Reform and Consumer Protection Act (Dodd-Frank), have negatively affected firms‟ excess returns; and 3) to evaluate whether the levels of opportunistic earnings management has decreased following these regulations[4].Prior research has focused on fundamental analyses aimed at determining the value of corporate securities through a careful examination of key value-drivers, such as earnings, risk, growth, and competitive position. Lev and Thiagarajan (1993) identified a set of financial variables (fundamentals), claimed by financial analysts to be helpful in the valuation of corporate securities, and examined these claims by evaluating the incremental value-relevance of these fundamentals over earnings. Their findings support the incremental value-relevance of most of the identified fundamentals; the fundamentals add approximately 60%, on average, to the explanatory power of earnings, with respect to excess returns for their sample period from 1974 to 1988. Hand (2000) asserted that the conventional assumption that accounting information maps into the equity market value in a linear and stationary manner is not relevant to technology-intensive firms
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