IMPACT OF ACCOUNTING PROFITS

ANNOUNCEMENTS ON SHARE PRICES

BALL & BROWN (1968):

• SEMINAL WORK IN POSITIVE ACCOUNTING AND
FINANCE LITERATURE
• TESTED THE USEFULNESS OF HISTORICAL COST PROFIT
FIGURE TO INVESTMENT DECISIONS
• IF THE HISTORICAL COST PROFIT FIGURE IS USEFUL
THE SHARE PRICE WILL REACT
IMPACT OF ACCOUNTING PROFITS
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Ball and Brown used 261 US company data in the period 1946-1966 to celebrate the impact of the
unexpected price.
Ball and Brown test results have some political implications finance :
• First, there is significant content information generated.
• Secondly, the evidence proves there is a release of the flow of information to the market and with
accounting not the only information about companies that work as feedback to the market.
• Third, the market is fairly consistent in anticipating the information in the report Accounting, and it is not
possible to trade in Accounting information, once information has been issued for economic gain after
transaction costs are taken into account.
IMPACT OF ACCOUNTING PROFITS
ANNOUNCEMENTS ON SHARE PRICES
Magnitude
• Recent studies are concentrated on the introduction of abnormal returns, ie positive or negative
abnormal returns associated with an increase or decrease in unexpected benefits.
• However, it is also possible to investigate the relationship between the magnitude of
unpredictable changes to profits and abnormal returns.
• The theory underlying these tests is that if an accounting profit has an information content, the
magnitude of the abnormal return will be related to the unexpected magnitude of the gain.
• In a further study of this relationship. Lambertdan Morse found that, on average, there was
only a 0.1- 0.15% abnormal return associated with an unexpected profit of 1%.
• That is, they do not find the fact that the sensitivity relationship between the proportion of
abnormal return with unexpected profit.
IMPACT OF ACCOUNTING PROFITS
ANNOUNCEMENTS ON SHARE PRICES
Information Asymmetry and Company Size
The content of unexpected earnings announcement information may be proportional reversed by the size of the
company, ie the smaller the company then the more information contained in the accounting statements.
Freeman argues that the probability of search costs increases related to the increasing complexity of large
corporations is offset by:
• Large companies provide more information than smaller companies.
• Large companies have a higher degree of exposure by constantly reporting on financial media and by financial
analyst activity.

In summary, the hypothesis of differential information implies that information contained in accounting should be
more important for companies small than big companies. Empirical research shows that profits provide more
information for small companies.
Freeman focused on the time difference in the adjustment process small and large companies for earnings
announcements. He points out that:
• The price of large corporate securities reflects initial earnings information from small firm security prices.
• The amount of cumulative abnormal return around the earnings announcement is greater for small companies than
large companies.
IMPACT OF ACCOUNTING PROFITS
ANNOUNCEMENTS ON SHARE PRICES

Volatility
Other researchers have used the alternative index of information content from earnings
announcement. One alternative is a variant of the abnormal return, first used by Beaver. The
theory underlying the test this is that if there is any information in the earnings announcement, we
are can expect price changes greater than price the announcement. This hypothesis was tested by
observing abnormal variations return (8 weeks before and 8 weeks after earnings announcement).
Results Beaver's study is consistent with this hypothesis, because in weeks the company's
variance return announcement is 67% greater than usually.
IMPACT OF ACCOUNTING PROFITS
ANNOUNCEMENTS ON SHARE PRICES

Association Studies and Earnings Response Coefficient (ERC)

ERC was investigated using OLS regression using return as its dependent variable. ERC is the
slope (coefficient) which shows informed earnings. Factors that affect Earning Coefficient
Response (ERC):
(1) Risk and uncertainty,
(2) Audit quality,
(3) Industry,
(4) Interest Rate,
(5) Financial Leverage,
(6) Level Company Growth,
(7) Permanent and temporary profits.
IMPACT OF ACCOUNTING PROFITS
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Determinants of Firm Value

Long-term association studies show a number of factors including risk
and uncertainty, firm size, industry, interest rate, financial leverage, potential growth, as well
as temporary and permanent profits has a role in determining the value of the company.
IMPACT OF ACCOUNTING PROFITS
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Factors wich Can Affect the ERC
Some of the factors that influence Earning Response Coeficient include:
a. Risk and uncertainty
b. Quality audit
c. Industry
d. Interest Rate
e. Financial Leverage
f. Company Growth Rate
g. Earnings permanent and temporary
h. Non-linear Modeling
i. Disaggregating Profits
j. Cash flows
k. Balance sheet and its components
IMPACT OF ACCOUNTING PROFITS
ANNOUNCEMENTS ON SHARE PRICES

Methodological Issues
Williams and Findlay stated that EMH labels affect prices securities. On the
other hand, Watts and Zimmerman state that managers using Williams and
Findlay states that EMH is more affect the price of securities. On the other hand,
Watts and Zimmerman states that managers use accounting to deceive market or
market efficiently and ignore the accounting changes that are not resulting in
cash flow.