Accounting Practices and the Market Valuation of
Accounting Numbers: Evidence from Indonesia, Korea,
Malaysia, the Philippines, Taiwan, and Thailand
Roger C. Graham* and Raymond D. King
y
*Oregon State University, Corvallis, OR, USA andyUniversity of Oregon, Eugene, OR, USA
Key Words:International accounting practices; Valuation; Asia; Clean surplus; Conservatism
Abstract:This study examines the relation between stock prices and accounting earnings and book values in six Asian countries: Indonesia, South Korea, Malaysia, the Philippines, Taiwan, and Thailand. The analysis is based on a residual earnings model that expresses the value of the firm in terms of book value and residual income. The model holds for any clean surplus accounting system. However, for finite time horizons, biased accounting may affect model estimates. The six countries examined in this study differ in faithfulness to clean surplus accounting as well as bias (conservatism). The study addresses two questions. First, are there systematic differences across countries in the value relevance of accounting, and are these differences related to accounting differences? Second, are there systematic differences in the incremental and relative information content of book value per share (BVPS) and abnormal (residual) earnings per share (REPS) across the countries, and are such differences related to accounting differences? We find differences across the six countries in the explanatory power of BVPS and REPS for firm values. Explanatory power for Taiwan and Malaysia is relatively low while that for Korea and the Philippines is relatively high. These differences are generally consistent with differences in accounting practice; however, since Korean accounting practice is strongly influenced by tax law, we did not expect the high association for Korea. Second, with respect to the incremental and relative explanatory power of BVPS and REPS, we find BVPS to have high explanatory power in the Philippines and Korea but little in Taiwan. In all six countries REPS has less explanatory power than BVPS in most years. Again, the evidence may be interpreted as suggesting accounting practice affects valuation (with Korea again as the exception). Finally, we provide evidence on the sensitivity of the timing of comparisons of stock prices and accounting values. We find that comparing prices at year-end (even though annual accounting information has not been released at that time), in general, provides the highest correlation between market and accounting numbers.
Differences in accounting practices across countries are a major concern to investors, accounting standard setters, stock exchanges, and financial analysts. The International
The International Journal of Accounting, Vol. 35, No. 4, pp. 445±470 ISSN: 0020-7063. All rights of reproduction in any form reserved. Copyright#2000 University of Illinois Direct all correspondence to: Raymond D. King, Lundquist College of Business, University of Oregon, Eugene, OR 97403, USA; E-mail: rking@oregon.uoregon.edu
Accounting Standards Committee (IASC) and the International Organization of Securities Commissions (IOSCO) have devoted considerable effort to standardization or harmoniza-tion of accounting practices across countries. Investment professionals claim that account-ing differences may impede international capital flows (Choi and Levich, 1991). This study examines the relation between accounting numbers and firm market values in six Asian countries with diverse accounting practices: Indonesia, Korea, Malaysia, the Philippines, Taiwan, and Thailand. We focus on the incremental and relative explanatory power of book value and residual earnings. Because accounting systems differ across the six countries, we examine whether those differences are related to the valuation usefulness of accounting measures. Our objective is to provide evidence on the value relevance of accounting numbers from different accounting systems. Such evidence should inform the current debate over international accounting standards and practices.
Our analysis follows a model developed by Preinreich (1938), Edwards and Bell (1961), and Peasnell (1982) and formalized by Ohlson (1991, 1995) and Feltham and Ohlson (1995) sometimes termed the Residual Earnings (Income) model. The model formally states a simple concept: firm value is a function of book value and future residual earnings. A key aspect of the model is that its valuation accuracy does not depend on a particular set of ``good'' accounting procedures. The only requirement on accounting procedures isclean surplus accounting, that is, book value of equity changes only with income or loss and net capital investments and withdrawals (dividends) by owners. In addition, empirical applications of the model to finite horizons are potentially affected by bias in the accounting system. Therefore, comparisons across countries with different accounting practices are one way to investigate the value relevance of different accounting practices. Across the six countries, accounting systems vary in their faithfulness to clean surplus accounting and in the extent to which they exhibit bias (conservatism). Hence, it is possible that accounting values from some of the countries may provide better estimates of firm value than accounting values from the other countries. Therefore, the usefulness of accounting for firm valuation may differ across countries as well. On the other hand, the accounting standards developed in these countries may be partly based on International Accounting Standards (IAS) or US GAAP. This would tend to make accounting procedures and their value relevance similar. Saudagaran and Diga (1997) report that of our six countries, only Korea has not adopted some or all of IAS.
We investigate the value relevance of different accounting practices using an empirical model that regresses current book value and current residual earnings on market prices. In contrast, the residual income model is based on expected residual earnings. Considerable prior research, as discussed in the next section, examines the contemporaneous relation between accounting and market values. In this study, we examine that relation for six Asian countries. However, our interest is in the relation between accounting practices and the value relevance of accounting numbers. We focus on differences in accounting procedures across the six countries that affect book value and residual earnings.1 The accounting procedures selected: accounting for goodwill, asset revaluations, leases, research and development (R&D) expenditures, and the equity method of accounting for affiliated companies each may be categorized in terms of faithfulness to clean surplus and extent of conservatism.
but firms in Taiwan do neither. This means that book values in the Philippines will reflect market values of assets more closely than in Taiwan. Therefore, we expect the explanatory power of book value will be greater for Philippine firms than for Taiwanese firms. As another example, only Indonesian and Malaysian firms capitalize leases and R&D expenditures and use the equity method for affiliated companies. These are less conservative accounting practices than alternatives used in other counties.
We find accounting in Korea and Taiwan to be least faithful to clean surplus accounting. Korea does not capitalize goodwill and asset revaluations are amortized to equity according to tax law. Taiwan does not capitalize goodwill nor allow asset revaluations. Korea is also the only country not to use the equity method for affiliated companies. Thus, the earnings of Korean firms do not include the earnings of affiliated firms. Philippine firms, however, amortize both goodwill and asset revaluations to income. Recall that violations of clean surplus accounting occur when income does not reflect changes in equity value. Thus, violations of clean surplus bias empirical calculations of residual earnings. Therefore, we expect the explanatory power of residual earnings will be highest for Philippine firms and least for Korean and Taiwan firms.
Overall, our results show significant differences across countries in the value relevance of accounting earnings and book values. Explanatory power over all firm-years ranges fromR2= .17 in Taiwan toR2= .68 for Korea. The incremental explanatory power of book value per share (BVPS) and residual earnings per share (REPS) is similarly diverse. Incremental explanatory power of BVPS over all firm-years ranges from 7.2 percent (Taiwan) to 65.3 percent (Philippines). For REPS, the incremental explanatory power over all firm-years ranges from 1.4 percent (Korea) to 13.2 percent (Thailand).
Generally, we find differences in accounting appear to be related to differences in value relevance. We find that the explanatory power of book value is highest in the Philippines and lowest in Taiwan. This is consistent with our expectations based on the accounting differences in the two countries. Indonesia and Malaysia have accounting systems that are less conservative than other countries. However, we find the incremental explanatory power of book value does not stand out as high in Indonesia or in Malaysia. This result is only partly consistent with our expectations. We also expected that the relative explanatory power of residual earnings would be high in the Philippines and low in Korea and Taiwan, and the results support this prediction. Our comparisons across countries should be viewed with caution because the number of years of data available ranges from only 2 years for the Philippines to 10 years for Malaysia.
The next section of the article briefly reviews related research and this is followed by the section discussing accounting differences in the six Asian countries. This is followed by the description of the sample and development the study design. The section presenting the analysis of our data and reporting the results of our tests follows. A final section summarizes our findings.
RELATED RESEARCH
stock prices with accounting book value and earnings; and second, research examining the
incrementalexplanatory power of book value and earnings in the presence of the other.
Stock Prices Explained by Book Value and Earnings Per Share
Examining a large set of US firms, Bernard (1993) found that book values explain 55 percent of the cross-sectional variation in market prices. When current return on equity (ROE; ranks) was added to the regression, these two accounting measures explain about 64 percent of the variation in market prices. Bernard (1994) finds that return on common equity (ROE) is mean reverting over time so that firms with the highest (lowest) current ROEs tend to have lower (higher) ROEs in later years.
King and Langli (1998) examine the explanatory power of BVPS and earnings per share (EPS) for three European countries: Germany, Norway, and the UK. They find significant differences in the valuation power of accounting book value and earnings across the three countries, and they interpret some of the differences as consistent with diversity in accounting practices. They also find future earnings realizations as proxies for expected earnings do not have incremental explanatory power beyond that of current earnings and book value.
Frankel and Lee (1999) look at the relation between accounting values, earnings forecasts and market prices across 20 countries (including Korea and Thailand) for 8 years, 1987±1994. Sample sizes for Korea and Thailand are small with 3 to 8 observations per year (33 total firm-years) for Korea and 1 to 40 observations per year (162 total firm-years) for Thailand. They find that estimates of value based on the residual earnings model have incremental explanatory power beyond book value and earnings in explaining market value in all countries. In addition, they find evidence of superior returns to trading strategies based on an estimate of value from a residual earnings model.
Joos and Lang (1994) relate book value and earnings to stock prices for France, Germany, and the UK. Their sample covers 1982 to 1990, and they focus on the effects of implementing the accounting related directives of the European Union. They find the explanatory power of book value and earnings together ranges from 20 to 38 percent for Germany, from 48 to 78 percent for France, and from 14 to 42 percent for the UK. They do not examine incremental explanatory power. Evidence on changes over time is ambiguous, probably because the time periods for the sample are relatively short.
Harris et al. (1994) examine the value relevance of accounting numbers for German firms compared to that for a matched set of US firms for 1982±1991. They find little difference in overall value relevance (R2) between German and US firms. However, coefficients (multiples) on book value and on earnings for German firms are greater than for matched US firms. Further, they find that consolidation increases the value relevance of accounting numbers, and restatements of earnings to adjust for transitory elements in German accounting also increases explanatory power.
Incremental Explanatory Power of Book Value and Earnings Per Share
in the ability of earnings to explain market prices over this period. But the explanatory power of book values increases such that total explanatory power is actually higher in more recent periods. Average adjusted R2 for a model regressing BVPS and EPS on stock price for the first 10 years (1953±1962) was .50 increasing to .69 for their most recent 10-year period (1984±1993). Collins et al. (1997) investigated possible reasons for these changes. They find the reduced explanatory power of earnings is explained by an increase in the incidence of one-time items and reported losses as well as a decrease in the size of firms in the sample.
King and Langli (1998) examine a 15-year period (1982±1996) for Germany, Norway, and the UK. They find that for Germany the incremental explanatory power of book value increases significantly while that for EPS decreases. There is no significant change in their common information. For Norway, there is no significant change in the incremental explanatory power of book value or EPS over time. While for the UK, the incremental explanatory power of book value increases and the incremental explanatory power of EPS is unchanged over the time period.
Harris et al. (1994) also examine the separate explanatory power of book value and of earnings using simple regressions with only one variable. They do not report the test statistics. However, they say that while the explanatory power of EPS in Germany is approximately equal to that in the US, the explanatory power of book value is much lower. This contrasts sharply to the King and Langli (1998) results for a longer time period. The Harris et al. (1994) results are not, however, tests of incremental explanatory power since the simple regressions use only one variable.
This study extends the evidence summarized above. We examine the value relevance of accounting numbers for companies in Asian countries. Prior financial reporting research in English language journals has been limited.
ACCOUNTING DIVERSITY ACROSS THE SIX COUNTRIES
The accounting systems in all six countries have developed relatively recently. The six accounting systems differ on some dimensions but are similar on others. Two dimensions that we examine are (1) the model on which the accounting systems are based and (2) the type of standard setting body. Table 1 shows these characteristics for the six countries. IAS was the primary basis for accounting standards in Indonesia, Malaysia, and Thailand (although Thailand has also been influenced by US GAAP). US GAAP, on the other hand, was the primary basis in the Philippines and Taiwan (although Philippine GAAP is secondarily based on tax law). Korean accounting standards are unique in that they are based on Korean tax law that, like tax law in all countries, emphasizes cash realization. Different accounting models may lead to differences in the value relevance of the resulting accounting numbers. We have no prior expectations concerning the relative value relevance of IAS versus US GAAP. It is likely, however, that tax law is more susceptible to political influence than other accounting bases. To the extent that such political influence might serve to make accounting less informative, Korean accounting may be less value relevant because it is based on tax law.
standard setting is influenced or controlled by government there is greater potential for political influence in the standards setting process. As where accounting follows tax law, this may lead to lower value relevance of accounting numbers.
We analyzed the accounting standards and practices for each country using a variety of sources including Akathaporn (1995), Graham and Wang (1995), and publications from the AICPA (1989, 1990, 1992), CIFAR (1995), Deloitte Touche Tohmatsu International (1995a,b, 1996a,b, 1997), Price Waterhouse (1995a,b, 1996a,b,c,d), and Mathew Bender & Co.(1996). Under the residual earnings model the only crucial accounting characteristics are unbiased accounting and clean surplus accounting. Conservative accounting practices are biased since value changes are reflected asymmetrically, value declines are recognized more quickly than value increases. The clean surplus relation (CSR) allows book value of equity to change only with income or loss and net capital investments and withdrawals (dividends) by owners. CSR is violated if changes in book value can by-pass income. We focus our analysis on the effects of accounting differences on book value and on residual (abnormal) earnings, the accounting arguments in the residual earnings model. However, account-ing differences affect valuation only when they are violations of unbiased accountaccount-ing or clean surplus accounting.
Differences Across Countries Affecting Book Value
Revaluing assets is a violation of CSR if the accompanying credit is taken directly to equity. Yet asset revaluations bring book value nearer to market value. Immediate write-off of goodwill violates CSR and usually moves book values farther from market values. In summary, both recognizing goodwill (consistent with CSR) and revaluing assets (violating CSR) bring book value nearer to market value. Hence, developing predictions on the effects of specific accounting treatments on value relevance is not always clear. Conservative accounting (bias) is expected to generally reduce the value relevance of both book value and earnings since the essence of conservatism is delay in reflecting certain events in the accounting records.
Recording goodwill is common practice in Indonesia and the Philippines, and uncommon but allowed in Malaysia and Thailand. Korea and Taiwan do not allow goodwill to be recorded. Asset revaluations are common in all countries except Indonesia and Taiwan where they are allowed but restricted in practice. Table 2 presents a summary of our analysis of these accounting practices.
Table 1. Accounting Standards and Standard Setting in the Six Countries
Asset revaluation and goodwill are both recorded only in the Philippines, and neither is recorded in Taiwan. The other four countries allow one procedure or the other but not both. We expect the incremental explanatory power of book value to be high in the Philippines and low in Taiwan relative to the other five countries. However, the effect of these accounting practices on the incremental explanatory power of book value for the other countries is ambiguous.
The six countries also differ in other accounting practices, including capitalizing leases, capitalizing research development costs, and applying the equity method to affiliated firms. Firms that capitalize and use the equity method are likely to have book values that are closer to market values than firms that do not.2Table 3 presents a summary of our analysis of these accounting practices.
Only Indonesia and Malaysia allow or require all three accounting procedures. The effect of these accounting differences on incremental explanatory power is ambiguous for the other countries. However, we expect the explanatory power of book value in Indonesia and Malaysia to be higher than in Thailand and Taiwan.
Differences Across Countries Affecting Residual Earnings
As explained in the previous section, conservatism is expected to reduce the value relevance of both book value and residual earnings. In addition, we can make some predictions about the effects of clean surplus accounting for goodwill and asset revalua-tions on the value relevance of book value. However, the effects of these accounting practices on the value relevance of residual earnings are less clear.
The Philippines is the most faithful to clean surplus accounting as both goodwill and asset revaluations are amortized to income over their useful lives. The other
Table 2. Goodwill and Asset Revaluations on the Balance Sheet
Country
Table 3. Other Asset Values on the Balance Sheet
countries (1) do not record goodwill (Korea and Taiwan), (2) do not record asset revaluations (Indonesia and Taiwan), (3) immediately write-off goodwill to equity (Malaysia and Thailand), or (4) amortize asset revaluation increments to equity (Korea, Malaysia, and Thailand). Korea and Taiwan are least faithful to clean surplus accounting. Korea does not capitalize goodwill and asset revaluations are amortized to equity according to schedules mandated by tax law. Taiwan does not capitalize goodwill nor allow asset revaluations. Korea is also the only country that does not use the equity method for affiliated companies; therefore the earnings of Korean firms do not include the earnings of affiliated firms. We expect the relative explanatory power of residual earnings to be high in the Philippines and low in Korea and Taiwan. The effect on the explanatory power of residual earnings for the other countries is ambiguous. Table 4 presents a summary of the amortization practices.
Summary of the Research Questions
Our examination of accounting practices reveals some systematic differences across the six countries. While the differences appear to be substantial, it is an empirical question whether they result in meaningful violations of the CSR or in significant accounting bias (conservatism), the important factors for the residual earnings model. Accounting bias will likely reduce the explanatory power of both book value and earnings. Furthermore, violations of the CSR may either increase or decrease the explanatory power of book value depending on whether the violation moves book value toward or away from market values. Because countries differ on both dimensions, ex ante hypotheses on which effect will dominate are problematic. Even so, we expect that bias and CSR violations will affect the value relevance of accounting numbers in systematic ways. Particularly because Philippine firms record both goodwill and asset revaluations and Taiwan firms do neither, we expect the value relevance of book value to be greatest in the Philippines and least in Taiwan. Because both Indonesian and Malaysian firms capitalize leases and R&D expenditures and use the equity method we expect the value relevance of their book values to exceed the value relevance of book value in Thailand and Taiwan. Because Philippine firms amortize both goodwill and asset revaluations to income, we expect the value relevance of residual earnings to be high in the Philippines.
In addition, we investigate changes in the value relevance of accounting numbers over time. Our sample contains 3,655 firm-years across six countries. We have sufficient data for only 2 years of yearly regressions for the Philippines but 10 years for Malaysia. We
Table 4. Goodwill and Asset Revaluation Amortization
Country
Korea ± ± shareholder equity per tax law
Malaysia ± immediate write-off shareholder equity useful life Philippines income no more than 40 years income useful life
Taiwan ± ± ± ±
trace the total explanatory power of accounting earnings and book value and the incremental explanatory power of each earnings and book value in the presence of the other across time for each country.
SAMPLE AND STUDY DESIGN
Our sample covers publicly traded firms in Indonesia, Korea, Malaysia, the Philippines, Taiwan, and Thailand across the period from 1987 to 1996. The stock prices and accounting data for this study are from the Worldscope Global Researcher. The sample selection criteria are:
1. Accounting data is from consolidated financial statements.
2. Financial firms are excluded (insurance, banks, and other miscellaneous financial firms). Accounting practices for these firms are so distinct that their valuation parameters are likely to be substantially different from those for industrial firms. 3. Firms with negative book values are deleted. These firms are likely to be in
financial distress and may be interesting in their own right. However, the focus of this study is the across country differences in value relevance of accounting numbers derived under different accounting practices. Hence, restricting our sample to firms with positive book values will allow us to focus on firms where differences are mostly likely to reflect accounting differences.
4. Twelve firms with EPS greater than their BVPS are deleted since data on those firms is likely to contain errors. These firms constituted less than 1 percent of the sample. 5. Twenty firm-years with excessive statistical influence in our regressions were deleted. The firm-years showed undue influence by the diagnostics and cutoff rules described in Belsley et al. (1980).
These restrictions on the sample will have several effects. First, the model will appear to ``fit'' better than it would fit unrestricted data. That is, the explanatory power of book value and of residual earnings information in the sample is likely to be greater than for an unrestricted sample. Second, the samples across the six countries will be more homo-geneous and the effects of different business cycles in the six countries will be reduced. This should allow a better focus on the effects of accounting differences. Table 5 shows the countries and number of firm-years.
Table 5. Sample Countries and Firm-Years
Sample selection Firm-years
Indonesia 338
Korea 902
Malaysia 1,311
Philippines 139
Taiwan 369
Thailand 596
Table 6 provides descriptive statistics for the sample. Per share values are in nominal currency of the countries, so comparisons are difficult. However, we can compare ROE (the ratio of EPS to average book value) across countries and the differences are substantial. Median ROE ranges from 6 percent (over 8 years) in Korea to 14 percent
Table 6. Descriptive Statistics on Variables for Six Southeast Asian Countries
Variable N Mean Standard deviation 5th Percentile Median 95th Percentile
Panel A: Indonesia
Price 338 2,813 2,261 556 2,236 6,500
BVPS 338 1,668 1,175 361 1,374 4,394
EPS 338 242 305 43 154 765
REPS 338 ÿ75 272 ÿ474 ÿ52 180
ROE 340 0.15 0.09 0.03 0.14 0.30
Panel B: Korea
Price 902 25,629 34,972 8,002 18,100 63,921
BVPS 902 21,019 31,375 6,282 14,104 50,225
EPS 902 1,353 4,324 ÿ979 786 5,007
REPS 902 ÿ372 3,334 ÿ3,291 ÿ398 2,389
ROE 902 0.07 0.14 ÿ0.09 0.06 0.26
Panel C: Malaysia
Price 1,311 5.16 5.99 0.94 3.84 13.96
BVPS 1,311 1.71 1.11 0.53 1.44 3.72
EPS 1,311 0.18 0.21 ÿ0.03 0.15 0.56
REPS 1,311 0.06 0.19 ÿ0.17 0.04 0.37
ROE 1,311 0.13 0.15 ÿ0.04 0.12 0.38
Panel D: Philippines
Price 139 19.06 31.65 0.17 6.37 81.37
BVPS 139 7.91 12.00 0.17 2.54 38.68
EPS 139 0.97 1.71 ÿ0.08 0.37 4.94
REPS 139 ÿ0.14 1.32 ÿ2.75 ÿ0.01 1.30
ROE 139 0.16 0.14 ÿ0.04 0.14 0.40
Panel E: Taiwan
Price 369 30.55 13.21 14.95 27.89 53.83
BVPS 369 12.43 2.81 7.80 12.19 17.51
EPS 369 1.20 1.25 ÿ0.79 1.16 3.16
REPS 369 ÿ0.18 1.25 ÿ2.17 ÿ0.21 1.84
ROE 369 0.10 0.11 ÿ0.06 0.09 0.26
Panel F: Thailand
Price 596 95.79 102.39 18.25 59.59 330.00
BVPS 596 41.35 35.05 11.05 31.09 117.83
EPS 596 5.93 8.32 ÿ1.14 3.59 21.24
REPS 596 ÿ0.23 5.10 ÿ6.41 ÿ0.78 7.48
ROE 596 0.12 0.14 ÿ0.06 0.13 0.34
(over 5 and 2 years) in Indonesia and the Philippines. For comparison, King and Langli (1998) find ROE over the 1980s and 1990s to be about 6 percent in Germany, 10 percent in Norway, and 13 percent in the UK. In the US, this measure has averaged around 13
Table 7. Correlation Statistics on Variables for Six Asian Countries (pvalues in parentheses)
Spearman
Variable N Price EPS BV ROE REPS
Panel A: Indonesia
Price 338 .6164 (.0001) .5685 (.0001) .2255 (.0001) .0662 (.2252) EPS 338 .5741 (.0001) .6915 (.0001) .5066 (.0001) .2846 (.0001) BV 338 .4777 (.0001) .6418 (.0001) ÿ.1406 (.0097) ÿ.3028 (.0001) ROE 338 .3423 (.0001) .6118 (.0001) ÿ.0130 (.8119) .8904 (.0001) REPS 338 .2498 (.0040) .6262 (.0001) ÿ.1012 (.0631) .7768 (.0001)
Panel B: Korea
Price 902 .5328 (.0001) .6021 (.0001) .3095 (.0001) .1727 (.0012) EPS 902 .6894 (.0001) .5552 (.0001) .8285 (.0001) .6624 (.0001) BV 902 .8177 (.0001) .7438 (.0001) .1374 (.0001) ÿ.0681 (.0408) ROE 902 .1667 (.0001) .4769 (.0001) .0865 (.0093) .7442 (.9190) REPS 902 .3395 (.0001) .8529 (.0001) .2766 (.0001) .5963 (.0001)
Panel C: Malaysia
Price 1,311 .6224 (.0001) .5572 (.0001) .3272 (.0001) .4496 (.0001) EPS 1,311 .4171 (.0001) .5419 (.0001) .7678 (.0001) .8697 (.0001) BV 1,311 .5031 (.0001) .5552 (.0001) .0160 (.5619) .1774 (.0001 ROE 1,311 .1093 (.0001) .6042 (.0001) .0117 (.6730) .9252 (.0001) REPS 1,311 .2564 (.0001) .9093 (.0001) .2102 (.0001) .7218 (.0001)
Panel D: Philippines
PRICE 139 .8133 (.0001) .8601 (.0001) .1725 (.0423) .1177 (.1676) EPS 139 .7593 (.0001) .7726 (.0001) .4577 (.0001) .3776 (.0001) BV 139 .7906 (.0001) .7790 (.0001) ÿ.0654 (.4441) ÿ.0715 (.4027) ROE 139 .0169 (.8439) .2416 (.0042) ÿ.1081 (.2052) .8089 (.0001) REPS 139 .0727 (.3949) .4301 (.0001) ÿ.1866 (.0278) .4931 (.0001)
Panel E: Taiwan
Price 369 .5043 (.0001) .3056 (.0001) .4399 (.0001) .4431 (.0001) EPS 369 .3618 (.0001) .2487 (.0001) .9499 (.0001) .9291 (.0001) BV 369 .2639 (.0001) .2422 (.0001) ÿ.0010 (.9853) ÿ.0390 (.4548) ROE 369 .3048 (.0001) .9353 (.0001) .0276 (.5972) .9804 (.0001) REPS 369 .3116 (.0001) .9609 (.0001) ÿ.0151 (.7731) .9909 (.0001)
Panel F: Thailand
Price 596 .7308 (.0001) .5639 (.0001) .6144 (.0001) .5523 (.0001) EPS 596 .6284 (.0001) .7144 (.0001) .8625 (.0001) .7757 (.0001) BV 596 .5145 (.0013) .8121 (.0001) .3443 (.0001) .2411 (.0001) ROE 596 .4415 (.0001) .5912 (.0001) .2494 (.0001) .9362 (.0001) REPS 596 .5166 (.0001) .8068 (.0001) .3405 (.0001) .7237 (.0001)
Price = Stock price at the end of yeart. EPS = Earnings per share for yeart. BVPS = Book value of shareholders' equity at the end of year t. ROE = Return on equity = EPSt/ ((BVPSt+ BVPStÿ1)/2). REPS = Residual (abnormal) earnings per share = EPStÿr*((BVPSt+ BVPStÿ1)/2) whereris the country average lending rate in yearttaken from the International Financial Statistics Yearbook.
Pear
percent over the last 20 years. Prior research has speculated that such differences across countries may reflect differences in conservatism of accounting methods. As noted above, for example, Taiwan does not record either goodwill asset revaluations (most conservative) while both are recognized in the Philippines (least conservative).
Table 7 reports the pair-wise correlation between stock price and accounting variables for all countries. For all countries except Korea the rank (Spearman) correlations are greater than the product±moment (Pearson) correlations. However, the patterns and significance of the parametric (Spearman) and non-parametric (Pearson) correlations are similar. Stock prices are strongly correlated with BVPS and with EPS for all countries. The pair-wise correlations between price and EPS are approximately the same as between price and BVPS. The correlation (Pearson) between BVPS and EPS is high in Thailand (.81), the Philippines (.78), and Korea (.74), and relatively low for Taiwan (.24). If EPS is used as a proxy for residual earnings, the high correlation between BVPS and EPS (they are related by size) may make it difficult to partition value relevance between book value and earnings. However, the pair-wise correlations between BVPS and REPS are far smaller, significant in some cases, insignificant in others, and sometimes negative. This is anticipated since there is no reason to expect residual (unexpected) per share earnings to be related to book value. One important reason for using REPS in the empirical analysis is to avoid the high correlation between BVPS and EPS.
TESTS AND ANALYSIS
Our analysis is based on contemporaneous cross-sectional regressions of accounting book values and residual earnings on stock prices (dependent variable). We analyze both the
relativeand theincrementalexplanatory power of book value and residual earnings using an approach applied previously in accounting by Biddle et al. (1995) and Collins et al. (1997). Empirical specification of the residual earnings model requires estimates of book value, residual earnings, and the horizon for residual earnings. For residual earnings estimated to terminate at time T, the model would be:
Priceita0a1BVPSita2REit1a3REit2a4REit3. . .akREiTeit 1
where Priceitis the price per share of firmiat the end of periodt, BVPSitis the book value per share of firmiat the end of periodt, and REitis the residual earnings per share of firmi
for yeart+k.
The coefficienta1would have an expected value of 1.0 while the coefficientsa2toa4 would have expected values of (1 +r)ÿt. Finally, the expected value of coefficient ak would be (1/r)*(1 +r)ÿT.3Residual earnings horizons will differ cross-sectionally; there-fore, parsimonious cross-sectional representations of Equation (1) will have only a few terms. For example Frankel and Lee (1999) useT= 2 because analysts' forecasts used to predict future residual earnings were only available for 2 years.
model on a per share basis (the horizon is only one period). Current period residual earnings is the proxy for future expected residual earnings. Residual earnings are estimated by subtracting an estimate of normal (expected) earnings from reported earnings. Expected earnings is the product of the estimated rate of return (r) and book value. Like Frankel and Lee (1999), we derive the estimated rate of return from interest rates in theInternational Financial Statistics Yearbook published by the International Monetary Fund (1997). Frankel and Lee (1999), however, are able to calculate a risk-adjusted return by adding a risk premium to long-term government bond rates Government bond rates are not available for four of the countries; therefore, we use commercial lending rates. Concep-tually, this rate is the sum of a riskless rate and the average commercial lending risk premium. In the residual earnings model, book value and firm value are taken at time t
while future abnormal earnings are for periods after time t. In our empirical analysis residual earnings (REt) are for the period ending at timet. Hence, as in Bernard (1994) and Collins et al. (1997), current earnings is a proxy for expected future earnings.
Priceitb0b1BVPSitb2REPSiteit 2
where Priceitis the stock price per share of firmiat the end of yeart, BVPSitis the book value of shareholders' equity of firmiat the end of yeart, REPSitis the residual earnings per share, which is equal to EPSitÿr*(BVPStÿ1)4(proxy for expected REPS in periodt+ 1), EPSitis the earnings per share of firmifor yeart, andris the country's average commercial lending rate in yearttaken from the International Financial Statistics Yearbook.
Book values and earnings are, of course, unobservable until some weeks after the end of the fiscal year. This raises the question of the timing of the market value measure to be associated with the accounting variables. As discussed by Barth et al. (1996), choice of contemporaneous versus lagged market values is a trade-off. The advantage to using a lagged market price is that it may reasonably reflect the accounting results since sufficient time has passed for these results to be public information. However, lagged market values will include effects of information and events occurring after the end of the fiscal year. Collins et al. (1997), examining associations between market and accounting numbers for US firms, take prices 3 months after the end of the fiscal period. In cross-country studies, however, this is problematic since the time lag between fiscal year-ends and report dates can vary widely. For this reason, our tests examine the relation between accounting numbers (book value and residual EPS for a fiscal year) and stock prices at the end of the fiscal year. Later, we analyze the sensitivity of our results using stock prices lagged 0 to 6 months following the end of the fiscal year.
Equation (2) expresses price as a function of book value and residual earnings. Examining the relative and incremental explanatory power of book value and of residual earnings requires two additional equations expressing price as a function of book value alone, Equation (3), and residual earnings alone, Equation (4).5
Priceitc0c1BVPSiteit 3
Following Theil (1971), we define the incremental explanatory power of the book value and residual earnings variables in terms of differences in the coefficient of determination (R2). These differences are sometimes called the semi-partial coefficient of determination (Cohen and Cohen, 1975, pp. 79±84). They are a measure of the incremental explanatory power of one variable given the remaining independent variables.
Define theR2statistics from Equations (2), (3), and (4) asRb2,Rr2, andRb2,r, respectively. Then the incremental explanatory power is defined as:
We can also assess therelativeexplanatory power of book value and residual earnings by comparing the conditional (incremental) power as shown above (Biddle et al., 1995).7 That is, we can also address the question of whether book values or residual earnings have greater explanatory power for each country.
Explanatory Power of BVPS and REPS Across the Six Countries
Table 8 reports summaries of regressions (2), (3), and (4) as well as incrementalR2for each year with 30 or more observations and for all years together for the six countries. First, we focus on the coefficients and the significance of regressions (2), (3), and (4), and then we analyze the relative and incremental explanatory power.8
Coefficients on BVPS are positive for all countries. They are significant overall and for most years. BVPS coefficients are greater than 1.0 for Malaysia (2.75), the Philippines (2.17), Taiwan (1.26), and Thailand (1.41) in regression (2). BVPS coefficients are less than 1.0 for Indonesia (.82) and Korea (.89). Coefficients on REPS are positive and significant for all countries except the Philippines. Coefficients on REPS for regression (4) range from 1.26 for Malaysia to 10.90 for Thailand.9
We find significant differences in the value relevance of accounting across countries. The explanatory power of book value and residual earnings is quite high for Korea and the Philippines, near to what is found for Anglo-American markets. However, the explanatory power for Taiwan is well below that found for most other countries. Table 9 presents a
R2bjr=R
2
b,rÿRr2 The incremental explanatory power of book value is the total explanatory power of book value and residual earnings less the explanatory power of residual earn-ings alone.
R2rjb=R2b,rÿR2b The incremental explanatory power of residual earnings is the total explanatory power of book value and residual earnings less the explanatory power of book value alone.
Table 8. Incremental and Relative Information Content of Book Values and Residual Earnings: Regressions of Book Value and Residual Earnings on Price by
Year (t-statistics in parentheses)
Priceitb0b1BVPStb2REPSeit R2b;r
Priceitc0c1BVPSteit R2b
Priceitd0d1REPSeit R2r
where Priceitis the price per share of firmiat timet, BVPStis the book value per share of firmiat the end of periodt, and REPStis the residual earnings per
share of firmifor yeart.
R2bjr=R 2
b,rÿR
2
r The incremental explanatory power of book value is the total explanatory power of book value and residual earnings less the
explanatory power of residual earnings alone.
R2rjb=R2b,rÿR2b The incremental explanatory power of residual earnings is the total explanatory power of book value and residual earnings less the
explanatory power of book value alone.
R2com= R2b,rÿR2bjrÿR2rjb The explanatory power common to book value and residual earnings is the total explanatory power of book value and residual earnings
less the incremental explanatory power of book value and the incremental explanatory power of residual earnings alone.
Year N b0 b1BV b2REPS Rb2,r c1BV Rb2 d1REPS Rr2 Rbj2r Rrj2b Rcom2
Panel A: Indonesia
All 338 1,400 (7.83) 0.96 (10.90) 2.49 (6.57) .308 0.90 (9.69) .219 2.07 (4.73) .062 .246 .089 ÿ.027 1991 46 698 (2.12) 1.62 (7.38) 6.08 (3.82) .559 1.16 (5.52) .409 ÿ0.34 (ÿ0.17) .001 .558 .150 ÿ.149 1992 61 596 (1.82) 1.75 (8.80) 5.66 (8.82) .564 1.32 (5.43) .358 2.46 (1.80) .052 .542 .236 ÿ.184 1993 63 1,864 (6.19) 1.04 (6.54) 0.86 (1.78) .419 0.99 (6.22) .388 0.34 (0.55) .005 .414 .031 ÿ.026 1994 70 1,495 (3.41) 0.79 (3.98) 3.07 (3.53) .332 0.90 (4.22) .208 3.59 (3.78) .173 .159 .124 .049 1995 80 1,526 (3.61) 0.63 (3.32) 3.41 (3.99) .266 0.66 (3.13) .114 3.50 (3.86) .161 .105 .152 .009
Meana 64 1,236 1.17 3.82 .434 1.01 .295 1.91 .078 .356 .139 ÿ.060
(continued)
P
ractices
and
the
Market
V
aluation
of
Accounting
Numbers
Table 8. (Continued)
Year N b0 b1BV b2REPS Rb2,r c1BV Rb2 d1REPS Rr2 Rbj2r Rrj2b Rcom2
Panel B: Korea
All 901 7,746 (9.48) 0.87 (40.07) 1.29 (6.27) .683 0.91 (42.61) .669 3.56 (10.83) .115 .568 .014 .101 1988 48 15,983 (10.36) 0.21 (2.43) 1.94 (2.41) .182 0.18 (1.96) .077 1.62 (1.93) .075 .107 .105 ÿ.030 1989 61 19,043 (16.22) 0.31 (4.26) 1.44 (2.53) .241 0.22 (3.32) .157 0.25 (0.45) .000 .241 .084 ÿ.084 1990 67 13,791 (17.12) 0.24 (4.49) 0.89 (2.11) .240 0.18 (3.87) .187 ÿ0.10 (ÿ0.26) .001 .239 .053 ÿ.052 1991 82 9,826 (9.51) 0.27 (5.08) 0.73 (2.09) .261 0.26 (4.75) .220 0.50 (1.25) .019 .242 .041 ÿ.022 1992 106 9,383 (5.75) 0.50 (7.13) 1.99 (5.53) .584 0.67 (9.42) .461 3.13 (7.97) .379 .205 .123 .256 1993 145 11,318 (4.75) 0.74 (9.49) 3.26 (4.60) .820 1.05 (23.44) .794 8.91 (18.64) .709 .111 .026 .683 1994 180 13,979 (8.06) 0.81 (18.06) 1.61 (3.48) .816 0.91 (26.96) .803 7.27 (12.73) .477 .339 .013 .464 1995 182 3,266 (2.25) 0.92 (28.72) 0.32 (1.02) .843 0.91 (30.87) .842 ÿ3.22 (ÿ4.81) .115 .728 .001 .114
Meana 109 12,074 0.51 1.52 .498 0.55 .442 2.92 .222 .276 .056 .166
Panel C: Malaysia
All 1,311 0.51 (2.00) 2.53 (19.54) 5.07 (6.55) .277 2.71 (21.06) .253 8.25 (9.60) .067 .210 .024 .043 1987 42 0.66 (1.77) 1.38 (4.08) 2.57 (2.59) .300 0.82 (2.97) .180 ÿ0.04 (ÿ0.04) .000 .300 .120 ÿ.120 1988 50 0.59 (1.89) 1.24 (4.88) 2.33 (3.00) .391 1.18 (4.20) .269 1.90 (2.08) .083 .308 .122 ÿ.039 1989 59 1.76 (4.54) 0.75 (2.65) 4.28 (3.78) .322 0.98 (3.16) .149 4.89 (4.21) .237 .085 .173 .064 1990 67 1.74 (4.27) 0.85 (2.75) 6.00 (4.71) .381 1.24 (3.59) .166 6.92 (5.37) .307 .074 .215 .092 1991 102 0.92 (3.69) 0.99 (6.35) 9.33 (9.96) .637 1.32 (6.13) .273 10.58 (9.78) .489 .148 .364 .125 1992 169 0.16 (0.66) 1.72 (12.57) 8.30 (8.36) .532 1.45 (9.17) .335 5.32 (3.96) .086 .446 .197 ÿ.111 1993 172 ÿ1.11 (1.30) 4.31 (9.70) 5.09 (1.62) .371 4.37 (9.80) .361 7.30 (1.88) .020 .351 .010 .010 1994 183 0.86 (1.04) 3.03 (7.84) 2.41 (0.91) .264 3.07 (7.98) .260 4.58 (1.50) .012 .252 .004 .008 1995 258 0.80 (1.33) 2.38 (8.77) 3.25 (1.90) .263 2.48 (9.30) .253 0.64 (3.30) .041 .222 .010 .031 1996 201 4.21 (4.02) 1.37 (5.21) 7.64 (3.33) .157 1.97 (4.95) .110 10.73 (5.04) .113 .044 .047 .066
Meana 130 1.06 1.80 5.12 .362 1.89 .236 5.28 .139 .223 .126 .013
THE
INTERNA
TIONAL
JOURNAL
OF
ACCOUNTIN
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V
ol.
35,
No.
4,
All 139 2.44 (1.32) 2.20 (16.75) 5.49 (4.60) .680 2.08 (1.30) .625 1.74 (0.85) .005 .675 .055 ÿ.050 1994 31 0.45 (0.15) 2.92 (14.63) 13.76 (6.67) .885 2.41 (8.27) .702 2.27 (0.41) .010 .875 .183 ÿ.173 1995 49 ÿ0.23 (ÿ0.16) 2.58 (22.99) 18.72 (10.09) .921 1.89 (10.88) .716 ÿ3.37 (ÿ0.68) .010 .911 .205 ÿ.195
Meana 40 0.11 2.75 16.24 .903 2.15 .709 ÿ0.55 .010 .893 .194 ÿ.184
Panel E: Taiwan
All 369 15.57 (5.43) 1.26 (5.64) 3.34 (6.63) .169 1.24 (5.24) .070 3.30 (6.28) .097 .072 .099 ÿ.002 1993 42 9.30 (0.84) 2.20 (2.38) 1.32 (0.65) .135 2.19 (2.40) .126 1.30 (0.60) .009 .126 .009 .000 1994 98 15.39 (3.82) 1.68 (5.08) 3.63 (3.79) .272 1.52 (4.36) .164 3.03 (2.84) .077 .195 .108 ÿ.031 1995 179 9.35 (3.43) 1.35 (6.63) 2.19 (5.21) .300 1.41 (6.47) .191 2.35 (5.02) .125 .175 .109 .016
Meana 106 11.35 1.74 2.38 .236 1.71 .160 2.23 .070 .166 .076 ÿ.006
Panel F: Thailand
All 596 51.28 (9.71) 1.28 (11.29) 7.76 (11.38) .397 1.50 (14.63) .265 10.37 (14.70) .267 .130 .132 .135 1991 40 18.63 (2.25) 1.81 (11.06) 2.84 (3.49) .848 2.06 (12.24) .798 6.67 (4.48) .345 .503 .050 .295 1992 74 27.59 (3.45) 1.68 (10.53) 5.55 (4.92) .727 1.93 (11.15) .635 9.42 (5.55) .300 .427 .092 .208 1993 130 102.78 (6.72) 0.57 (1.91) 12.64 (5.39) .300 1.33 (4.55) .139 14.74 (7.05) .280 .020 .161 .119 1994 166 47.66 (5.60) 1.10 (6.80) 9.18 (8.39) .512 1.53 (8.39) .300 11.56 (9.88) .373 .139 .212 .161 1995 175 38.21 (2.80) 1.12 (6.64) 7.14 (5.65) .369 1.38 (7.62) .251 9.33 (6.91) .216 .153 .118 .098
Meana 117 46.97 1.26 7.47 .551 1.65 .425 10.34 .303 .248 .126 .177
a
The mean coefficient is the average of yearly regression coefficients, and thet-statistic is the average coefficient divided by its time-series standard error. The meanR2
is the average of yearlyR2 .
P
ractices
and
the
Market
V
aluation
of
Accounting
Numbers
ranking from the highest to lowest explanatory power for the samples pooled over all years and for the yearly average.
The mean yearly R2 are greater than the pooled firm-years for all countries except Korea. Fitting the model for each year allows for yearly variation in the relation and results in a better fit than pooled firm-years. Table 8 reveals considerable year to year variation in the coefficients.
The following initial conclusions seem warranted. First, coefficients on book value and earnings are not greatly different from those found for European and American markets. Second, there is a high level of cross-country variation in explanatory power of accounting earnings and book values for stock prices. The six Asian countries in this study differ more than European and North American countries in prior studies. Third, earlier in this article we predicted, based on accounting differences, that accounting values in the Philippines would have high explanatory power for firm value but low explanatory power in Taiwan. Both of these predictions are substan-tiated. However, contrary to our predictions Korean accounting values have high explanatory power. This appears anomalous given the reliance of accounting practice on tax law in Korea.
Incremental Value Relevance of BVPS and REPS
Next, we examine the incremental explanatory power of BVPS beyond that for REPS, Rbjr2, and the incremental explanatory power of REPS beyond that of BVPS,
Rrjb2. Relative explanatory power can be addressed by comparing Rbjr2 and Rrjb2 to each other (Biddle et al., 1995). Table 8 reports these results for each year and for all years together. Fig. 1 shows the patterns across time. Focusing on the incremental explanatory power of BVPS, Rbjr2, we find the incremental power of BVPS ranges widely across the six countries, from a low of .070 in Taiwan to a high of .669 for Korea. Except for Taiwan, BVPSs have higher explanatory power than in prior studies. Prior studies (Harris et al., 1994; Collins et al., 1997; King and Langli, 1998) have used EPS rather than REPS to measure abnormal future earnings. EPS is typically highly correlated with BVPS and hence, the incremental explanatory power of book value is reduced. REPS is not highly correlated with BVPS and as a consequence BVPS has relatively more explanatory power. Table 10 lists from highest to lowest the incremental explanatory power for BVPS for the samples pooled over all years and for yearly means.
Table 9. Explanatory Power of Book Value and Residual Earnings
Country R2all firm-years Country Mean yearly R2 Number of years
Korea .683 Philippines .903 2
Philippines .680 Thailand .551 5
Thailand .397 Korea .498 8
Indonesia .308 Indonesia .434 5
Malaysia .277 Malaysia .362 10
In the section of this article discussing the accounting diversity across the six countries, we predicted that the Philippines, Indonesia, and Malaysia would have high incremental explanatory power for book value with low explanatory power in Taiwan and Thailand. Our expectation that the explanatory power of book value would be highest in the Philippines and the lowest in Taiwan is supported. However, the incremental explanatory power of book value in Indonesia and Malaysia do not stand out as high.
Focusing on the incremental explanatory power of REPS,Rrjb2, we find the incremental power of REPS is much lower than that for BVPS. Furthermore,Rrjb2appears more stable over time. Table 11 lists the highest to lowest incremental explanatory power for REPS for the samples pooled over all years.
Thailand ranks first (third) in incremental explanatory power for residual earnings for pooled firm-years (yearly average). The Philippines shows some evidence (yearly
average) of the hypothesized high incremental explanatory power. Residual earnings have little explanatory power for Korea. Since prior studies have examined EPS rather than REPS, these results are not strictly comparable. We also ran the regressions using EPS and find marginally lower incremental explanatory power for EPS than for REPS. However, the incremental power of BVPS was lower as well. Our results reflect the difficulty in making predictions about the explanatory power of residual earnings across countries.
Explanatory Power of BVPS and REPS Over Time
Following Collins et al. (1997) and King and Langli (1998), we examine changes across time in the explanatory power of book value and residual earnings. The incremental explanatory power of BVPS and REPS differ greatly over time and across countries. The
time patterns revealed in the regressions are illustrated in Fig. 1. The time patterns show that the overall explanatory power is increasing for Korea, the Philippines, and Taiwan, and declining for Indonesia and Thailand and mixed for Malaysia. Similarly, the incremental explanatory power of BVPS is increasing for Korea, the Philippines, and Taiwan, decreasing for Indonesia and Thailand, and mixed for Malaysia. For the incremental explanatory power of residual earnings, results show increases in the Philippines, Taiwan, and Thailand, decreases for Korea, and mixed patterns for Indonesia and Malaysia.
Sensitivity to the Timing of Price
We examined the sensitivity of our results to the date at which the stock price is taken. At the end of the fiscal year, information in the financial reports including book values and earnings are not available to investors. Use of lagged stock prices would allow for that financial statement information to be impounded into price. On the other hand, later prices will include information concerning events subsequent to the fiscal year thereby confounding the relation between accounting and firm value. To test the sensitivity of the price date, we run the regressions for lags of 0 to 5 months. Table 12 reports the total and incremental explanatory power for BVPS and for REPS for these six price dates.10 Only Indonesia and Korea show higher R2s for prices lagged after fiscal year-end. Total explanatory power for Indonesian (Korean) firms is greatest when prices are measured 4 (2) months after the fiscal year-end. The differences in R2 are not large, and the higher R2s do not affect the ordering of countries in Tables 9±11.
Table 10. Incremental Explanatory Power of BVPS
Country Rb2jrall firm-years Country Mean yearly Rb2jr Number of years
Philippines .653 Philippines .893 2
Korea .568 Indonesia .356 5
Indonesia .246 Korea .277 8
Malaysia .211 Thailand .248 5
Thailand .130 Malaysia .223 10
Taiwan .072 Taiwan .165 3
Table 11. Incremental Explanatory Power of Residual Earnings
Country Rrj2ball firm-years Country Mean yearly Rr2jb Number of years
Thailand .132 Philippines .194 2
Taiwan .099 Indonesia .139 5
Indonesia .089 Thailand .127 5
Philippines .055 Malaysia .126 10
Malaysia .024 Taiwan .075 3
SUMMARY AND CONCLUSIONS
In this study, we examine the accounting systems in six Asian countries to assess whether they differ in their value relevance under the residual earnings model. The countries selected: Indonesia, Korea, Malaysia, the Philippines, Taiwan, and Thailand, differ in the conservatism of their accounting practices, as well as in their adherence to clean surplus
Table 12. The Information Content of Book Values and Residual Earnings: Regressions of Book Value and Residual Earnings on Lagged Prices
Dependent variable N Rb2,r Rb2 Rr2 Rb2jr Rr2jb
Panel A: Indonesia
Price at year-end 338 .308 .219 .062 .246 .089
Price after 1 month 284 .280 .181 .069 .211 .099
Price after 2 months 319 .296 .196 .075 .221 .100
Price after 3 months 319 .310 .212 .073 .237 .098
Price after 4 months 318 .366 .212 .115 .251 .154
Price after 5 months 322 .355 .194 .125 .230 .161
Panel B: Korea
Price at year-end 902 .683 .669 .115 .568 .014
Price after 1 month 884 .729 .717 .114 .615 .012
Price after 2 months 884 .773 .754 .139 .634 .019
Price after 3 months 884 .764 .741 .150 .614 .023
Price after 4 months 884 .755 .744 .115 .640 .011
Price after 5 months 884 .751 .739 .117 .634 .012
Panel C: Malaysia
Price at year-end 1,311 .277 .253 .066 .211 .023
Price after 1 month 1,310 .151 .133 .043 .108 .018
Price after 2 months 1,310 .159 .150 .033 .126 .009
Price after 3 months 1,310 .147 .133 .036 .111 .014
Price after 4 months 1,310 .135 .123 .032 .103 .012
Price after 5 months 1,310 .137 .122 .037 .100 .015
Panel D: Philippines
Price at year-end 139 .680 .625 .005 .675 .055
Price after 1 month 139 .410 .354 .015 .395 .056
Price after 2 months 139 .438 .411 .002 .436 .027
Price after 3 months 139 .445 .435 .001 .444 .010
Price after 4 months 139 .420 .413 .001 .419 .007
Price after 5 months 139 .323 .308 .000 .323 .015
Panel E: Taiwan
Price at year-end 369 .169 .070 .097 .072 .099
Price after 1 month 366 .138 .057 .078 .060 .081
Price after 2 months 366 .130 .057 .072 .058 .073
Price after 3 months 366 .108 .050 .057 .051 .058
Price after 4 months 366 .092 .059 .036 .056 .033
Price after 5 months 366 .091 .052 .037 .054 .039
accounting. The study addresses two questions. First, are there systematic differences across countries in the value relevance of accounting numbers? Second, are there systematic differences in the incremental and relative contribution of book values and residual earnings to value across the countries related to accounting differences?
Our results indicate first, that accounting book value and residual earnings are positively and significantly related to current stock prices across all six countries consistent with King and Langli's (1998) findings for European countries and Bernard's (1994) results for US firms. Our results also show significant differences in the relation between accounting numbers and stock prices across the six countries and across time. We find some consistency between our predictions of explanatory power of accounting for firm value based on accounting practice in the six countries; however, the predictions are incomplete and some results are not consistent. While this study suggests that differences in the explanatory power of accounting are related to accounting differences across the countries, more evidence is needed. Second, when we focus on the relative and incremental explanatory power of book value and residual earnings, the empirical results again vary across countries more than for European and American markets in prior studies. Again, there are some tantalizing hints that accounting practice is related to these differences, but more evidence is needed.
The extent to which accounting differences are related to valuation differences is of concern in the debate on international accounting standards and practices. The body of research examining the value relevance of accounting includes North American (Bernard, 1994; Collins et al., 1997), European (Joos and Lang, 1994; King and Langli, 1998), and now Asian countries. The evidence seems clear that strongly conservative (biased) accounting is less value relevant. The evidence concerning violations of the CSR is less clear. Conceptually, violations of CSR that cause book values to be closer to market values, e.g., asset revaluation, increase the value relevance of book value. However, CSR violations that move book value away from market value, e.g., immediate write-offs of goodwill, will decrease the value relevance of book value. Evidence to date is broadly consistent with these expectations. Less clear are the predicted and actual effects of CSR violations on the value relevance of residual earnings.
The study makes two additional contributions. First, we compute incremental expla-natory power for residual earnings (the appropriate value under the residual earnings model) rather than for earnings as in prior studies. Residual earnings have little correlation with book value and allow a better separation of the explanatory power of book value and earnings. Second, we investigate the effects of different price dates in the relation. We find that year-end stock prices are more highly correlated with accounting variables in most countries and are near to the highest correlation in all countries.
NOTES
1. The explanatory power of book value and residual earnings will not be affected if a bias is
constant across firms and time. However, the accounting procedures examined are unlikely to be constant either across firms or across time.
2. Each of these accounting procedures will be relevant to only a subset of firms. Hence, the
3. The expected coefficients in Equation (1) can be see from the equation for firm value with a finite horizon (for example, see Equation (5) in King and Langli, 1998).
4. We useaveragebook value to calculate our proxy for abnormal earnings rather thanbeginning
book value as defined by the residual earnings model. Since we use actual earnings as the proxy for expected future earnings, average book values represent the book values in place that generated those earnings. Regression results for residual earnings calculated from beginning book values (not reported) are essentially equal to, but have slightly less explanatory power than, the results reported in this study.
5. The coefficientsb2andd1in Equations (2) and (4) arenotequal to thea2coefficient in Equation
(1). The earnings proxy used in Equations (2) and (4) is residual earnings for the current year rather than future expected residual earnings. The exact relationship in the coefficients in Equations (2) and (3) relative to that in Equation (1) is difficult to specify. However, it is easy to
show thatb2andd1must be smaller thana2.
6. Theil (1971, pp. 167±171) shows that where the independent variables are not orthogonal, the
sign of the difference between totalR2(Rb,r
not determined. That is,Rcom2 may be either positive or negative.
7. Biddle et al. (1995) show that this procedure is equivalent to comparing the explanatory power
of single regressions. In other words, whether book value or residual earnings has greater
relative explanatory power can be determined either comparing theR2s from Equations (3) and
(4) or by comparing the incrementalR2s (i.e.,R
b2jrtoRr2jb).
8. To compare with prior research, all of the analyses in this article were repeated with EPS
replacing REPS. EPS has greater explanatory power than REPS in most years for all countries. REPS has a lower (sometimes negative) correlation with book value than EPS. Consequently, book value has greater incremental explanatory power in the presence of REPS than with EPS. However, the general tenor of the results and the time-series patterns are quite similar.
9. Multicollinearity is not a problem in our regressions. None of the regressions containing both
book value and residual earnings has variance inflation factors greater than 2. Hetero-scedasticity in the error terms was detected, however, in the Indonesia and Malaysia regressions
containing both book value and residual earnings. We report White's adjustedt-statistics for
those two countries.
10. We do not have share price data for Thailand for months beyond year-end, so Table 12 covers
only five countries.
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