RELEVANCE OF ACCOUNTING INFORMATION IN NIGERIA (2004-2008)

CHAPTER ONE

INTRODUCTION

1.1              BACKGROUND OF THE STUDY

In broad terms, the accounting function has grown to become an integral component of the corporate system.  It exists because it satisfies primarily a need for information. Consequently, for more than four decades of accounting research especially capital market based research, emphasis has been placed on market efficiency i.e. testing the information content of accounting numbers, in an attempt to determine whether or not accounting information is value relevant and useful for investment decision making. Researches in this field began from the seminal works of Ball and Brown (1968) and Beaver (1968) that examined empirically the value relevance of accounting earnings and its implications for users of such information. While accounting theorists and practitioners held a dim view of whether historical cost accounting numbers accurately reflected a firm’s financial health, scientific evidence on the issue did not exist. Providing empirical evidence to ascertain whether accounting numbers contained or conveyed information about a firm’s financial performance was the major motivation that led to the research of Ball and Brown (1968) and Beaver (1968). There were three major concurrent developments in finance and economics that forged the way for the seminal research by both Ball and Brown (1968) and Beaver (1968).The subject of value relevance has now been placed on the pedestal of accounting based capital market studies and is of a great interest to investors, managers, standard setters, and other market participants. The interest stems from the fact that security prices determine the allocation of wealth among firms and individuals. The security prices themselves are influenced by financial information, which explains academic and practicing accountants and standard setters’ interest in market efficiency research. 

The term relevance as a quality of accounting information as used in accounting literature is defined by the American Accounting Association (1966:9),  “For information to meet the standard of relevance, it must bear on or be usefully associated with the action it is designed to facilitate or the result desired to produce. This requires that either the information or the act of the communicating exert influence on the designated action”. Relevance thus implies the ability of the information to influence decisions of both potential and existing investors whether by changing or confirming their expectations about the result or consequences of actions or events. Accounting value relevance is a concept that has admitted a number of definitions and measures.

Gordon and Gordon (2002) in their empirical explanation of “value relevance posit that Value relevance measures the joint response of earning or some other measure of the accounting and market returns to information arrival. Gordon et al (2002) further explain that value relevance represents the association between the information impounded in the accounts and the information impounded by the market.

According to Beaver (1968), Value relevance is the explanatory power of accounting information with respect to security prices. In their empirical study, LO and Lys (2000) state that Value relevance of accounting information or number, is the examination of the association between market value and accounting summary measures such as earnings and book values. The usefulness of accounting information or value relevance in equity valuation has been a primary paradigm in financial accounting research.

The studies on value relevance are broad and diverse. It is important to define the structure of concept of value relevance for this study. Some researchers may regard ability of accounting information to summarize business transactions and other events(the measurement view of value relevance) as sufficient proof of value relevance of accounting data, others may place greater emphasis on earnings prediction (the prediction view of value relevance) or information content of accounting data(the information view of value relevance), and so on. Therefore, the approach used for this study to determine the value relevance of accounting data in Nigeria. This is ability of financial statement to capture or summarize information that affects equity value.

According to Kothari (1999) a review of extant literature reveals that two approaches have often been employed to testing the value relevance of accounting information. They are; Events studies and Association studies. In an event study, one infers whether an event, such as an earnings announcement, conveys new information to market participants as reflected in changes in the level or variability of security prices or trading volume over a short time period around the event (Collins and Kothari, 1989, Watts and Zimmerman, 1986). If the level or variability of prices changes around the event date, then the conclusion is that the accounting event conveys new information about the amount, timing, and uncertainty of future cash flows that revised the market’s previous expectations and thus value relevant. The maintained hypothesis in an event study is that accounting information is value relevant in the sense that security prices are quick to reflect the newly arrived information. Since event studies test for the arrival of information through an accounting event, they are also referred to as tests of information content in the capital markets literature in accounting. Besides Ball and Brown (1968) and Beaver (1968), other examples of event studies include Foster (1977), Wilson (1986), Ball and Kothari (1991), Amir and Lev (1996), and Vincent (1999). Problems associated to this method consist firstly, on the difficulty of choice of the adequate interval of measure, which must surround normally the event by some hours, days or weeks before and after the announcement and secondly, on the conclusion from results of those studies, which can question the truthfulness of hypothesis of market efficiency.

On the other hand, Association studies consist on estimating regression models of market performance of the company on its financial performance and allow us to measure the degree of correlation between prices movements and accounting information on a very definite interval of time. We use in general the adjusted coefficient R2 which informs us about the explanatory power of accounting information as regards its relevance to explain prices movements. Therefore, the response coefficient of explanatory variables is used as indicator of their information content and their value relevance.

However, the empirical results on the subject of value relevance in contemporary researches especially across emerging stock markets tend to be inconclusive. Numerous literatures in the developed countries have created the impression that accounting information and numbers have lost their value relevance (Core,Guay & Buskirk, 2003; Dontoh, Radhakrishnan and Ronen 2001). The criticisms leveled are based on the following; the transformation in firm’s structure and activities, Fraud, window dressing of financial report and rapidly changing business environment. Although, other studies (Collins, Maydew and Weiss 1997, Balachandran and Moharan 2006), notes that the claims that accounting information has lost its value relevance may be quite premature.

In our perspective, the issues go beyond the fundamental analysis of the adequacy of accounting information with regards to its value relevance on one hand to issues of user trust and public confidence on the accounting information provided. Accounting informativeness becomes relevant to the extent that it forms the basis for investment decision and explains an appreciable level of investor behavior. Thus, in a situation of investor apathy resulting from distrust and declining user and public confidence on corporate claims as presented in public financials and other means of communicating to the market, the value relevance of accounting information would thus be unpredictable. This study attempts to examine the subject of value relevance of accounting information in the Nigerian capital market and consequently, boost the empirical evidence from emerging markets.

1.2       STATEMENT OF THE PROBLEM

Fundamental capital market analysis such as knowing the market position, amount and value of shares available for offer, when to buy or sell a particular stock, how much he should invest in such stocks, needs relevant accounting information in the form of financial statement, accounting numbers, figures and data.Therefore for such information to be valid, it must be accurate and give a true picture of the market situation of recent there has been criticism by capital market researchers in accounting with regards to the value relevance of accounting information. Numerous literatures in the developed countries have created the impression that accounting information and numbers have lost their value relevance (Dontoh, Radhakrishnan and Ronen 200, Core,Guay & Buskirk, 2003). The criticisms leveled are based on the following; the transformation in firm’s structure and activities, Fraud, window dressing of financial report and rapidly changing business environment.

On the contrary, studies (Collins, Maydew and Weiss 1997, Balachandran and Moharan 2006), notes that the claims that accounting information has lost its value relevance is premature. Balachandran and Moharan (2006) in a recent study of the value relevance of accounting information, concludes that there is no evidence that there is increasing decline in value relevance. Furthermore, Callao, Cuellar and Jarne (2006) perform a comparative analysis of the value relevance of reported earnings and their components. Their study gave evidence of value relevance of net earnings figure. Gjerde, Kaivsla and Saettem (2007) find that the time trend of overall value-relevance has not declined after controlling for changes in underlying economic variables.

This inconclusive evidence in literature has created a gap. Thus there is a need to examine the issue from different research context and data sets. It is against this background that this study attempts to examine the value relevance of accounting information in the Nigerian capital market and thus provide evidence from Nigeria.

In the light of this, the research questions are;

1.           Is the informativeness of earnings per share value relevant in the Nigerian capital market?

2.           Is the informativeness of Return on equity value relevant in the Nigerian capital market?

3.           Is the informativeness of dividend per share is value relevant in the Nigerian capital market?

4.           To examine if the informativeness of Earnings yield is value relevant in the Nigerian capital market.

1.3       RESEARCH OBJECTIVES

The main objectives of the study are to examine the value relevance of accounting information in the Nigerian stock market and thus provide evidence from Nigeria.  The objectives are stated as follows;

1.                  To examine if the informativeness of earnings per share is value relevant   in the Nigerian capital market.

2.                  To evaluate whether the informativeness of Return on equity is value relevant   in the Nigerian capital market.

3.                  To ascertain if the informativeness of dividends per share is value relevant in the Nigerian capital market.

4.                  To examine if the informativeness of Earnings yield is value relevant in the Nigerian capital market.

1.4   RESEARCH HYPOTHESES

The following hypotheses were formulated for the purpose of the study. The hypothesis will test the value relevance of specific accounting numbers analyzed individually and jointly. The purpose is to examine the incremental value relevance effects of multiple accounting numbers.

1.                   The informativeness of earnings per share is value relevant in the Nigerian capital market.

2.                  The informativeness of Return on equity is value relevant in the Nigerian capital market.

3.                  The informativeness of dividends per share and Return on equity considered jointly improves value relevance in the Nigerian capital market.

4.                  To examine if the informativeness of Earnings yield is value relevant in the Nigerian capital market.

1.4    SCOPE OF THE STUDY

The scope of the study may be specified in terms of the boundaries of the subject matter, the number of companies and the time period respectively.

This study attempts to examine the value relevance of accounting information in Nigeria. Thus the study examines selected accounting numbers and examines their value relevance in the capital market with regards to share price behavior. The study examines twenty quoted companies for a four year period (2004-2008).

 1.5     SIGNIFICANCE OF THE STUDY

The study will explore the value relevance of accounting numbers. It is hoped that the study will serve as an inspiration to other potential students, institutions, stock market researchers in accounting or individuals as well as contribute to the growth and development of the Nigerian stock market, serve as data bank for future research. Since no comprehensive study has explored this subject, therefore this study attempts to fill in the gap in literature and knowledge. Moreover, it is hoped that the study will assist in practice and standard setting, which in turn will increase investor’s confidence in the Nigerian stock market.

1.6       LIMITATION OF THE STUDY

While there have been a number of studies on this topic in developed countries, as at when this research took place and based on existing knowledge no comprehensive study has explored the subject. This resulted in difficulties in the collation and assessing of numerous indigenous write-ups and opinions. We consider this a limitation to the study.

REFERENCES

American Accounting Association (1996): “A statement of basic 

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Amir, E. (1996): Value-relevance of nonfinancial information:

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Balachandran S.V. and P.S. Mohanran (2006): Conservatism and

the Value Relevance of Accounting Information, Working Paper (University of Columbia).

Ball, R., and Brown, P., (1968: An empirical evaluation of

accounting income numbers, Journal of Accounting Research 6, 159-177.

Ball, R., and Kothari, S., (1991) Security returns around earnings

            announcements, The Accounting Review 52, 1-21.

Beaver, W., (1968): The information content of annual earnings

announcements, Journal of Accounting Research Supplement 6, 67-92.

Brown, S., K. Lo and  T. Lys(1999): Use of R2 in Accounting

Research: Measuring Changes in Value Relevance over the Last Four Decades. Retrieved June 20, 2007 from http:// www.sirca.org.uk.

Callao, S., B. Cuellar and J. I. Jarne (2006). “International

differences in Value Relevance of accounting Data and Explaining Country Factors.” International Journal of Accounting, Auditing and Performance Evaluation, 3(4), 387-408.

Collins, D. W., E.L. Maydew and I.S. Weiss (1997). “Changes in

            the Value –Relev