A survey of value relevance of the consolidate earnings and cash flows in the stock return of the companies listed in TSE
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1 International Research Journal of Applied and Basic Sciences 203 Available online at ISSN X / Vol, 6 (): Science Explorer Publications A survey of value relevance of the consolidate earnings and cash flows in the stock return of the companies listed in TSE Yadollah Noorifard, Mahnaz Rabiei 2 and Hossein Haghshenas *3. Department of accounting islamic Azad University, South Tehran branch, Tehran, Iran. 2. Department of economic, islamic Azad University, South Tehran branch, Tehran, Iran. *3. islamic azad university-south Tehran branch,amol, Iran. Corresponding Author h.haghshenas@yahoo.com ABSTRACT : The presentation of financial statements of the companies is used by the information of consolidated operation as an instrument to increase the value of the companies. The consolidated information compared to the information achieved of the parent companies was important in determining the changes of stock return and this is investigated in the present study. 8 Companies of listed companies in TSE were selected as parent companies and Subsidiary companies. To evaluate the hypotheses, correlation tests and regression were used. Based on the results during the study year, by considering all information of the variables, consolidated cash flow and consolidated earnings of the companies had significant effect on stock market return; it means that they had incremental information content compared to other variables. Keywords: Consolidated earnings, cash flow, stock return, value relevance INTRODUCTION Earnings is of great importance as the change index in stock holders equity or net assets of a business unit and are used as a criteria to evaluate the success and failure of the operation of a business activity. To increase this index, combination method with more efficiency, production variety, low production costs, tax benefits, reduction of risk, saving the costs, high sale volume are attracted by many investors (Divandari and Zali, 200). All these factors lead into the increase of company value. But the market value of the parent company is not only affected by the assets and debts, the control of the parent company on subsidiary companies are important in determining the future revenue of the parent company and the stock earnings. One of the accounting changes being considered in recent years is providing cash flow statement as one of the main financial statements by business units. Using cash ratios can be of great importance in evaluation and paying the debts of business institution. The ability to predict the bankruptcy of business institution is of great importance in terms of private investment and social view (Alivar, 994). Using traditional analysis method of the ratios in annual audit caused that although the company is faced with serious risks of cash, obligations and paying the debts, positive current ratios presented good income position and the company will go bankruptcy very soon. When liquidity analysis issue is raised, the information of cash flow is more reliable than balance sheet information. The data of balance sheet is static and the economical enterprise condition is measured at a time scale while cash flow statement reports the changes in other financial statements and eliminates the optional assignments by emphasis on what the stock holders give importance (Pakzad, 2002). According to the decisions of technical committee of audit organization in Iran, cash flow statement was considered as the basic financial statements since Bahman 996 and it was replaced by the changes in financial statement and was included in the comments of independent auditors. Although the auditors can use cash flow statement for evaluation of activity continuance, they only use current ratio and future ratio in cash analyses. An auditor to achieve a complete perception of the continuous of the activity of a company achieves the best result by calculation of some simple ratios based on cash flow statement data. Generally, financial ratios are one of the evaluation tools of the companies by investors and tools for management of business institution to evaluate the existing condition of business unit. These ratios are calculated based on the figures in financial statements being provided based on accrual accounting method. However, financial statements don t reflect information accrual about cash flows and it is one of the major weaknesses of accrual financial statements.
2 Theoretically, the logical expectation is that the more the consolidated earnings of the parent company, the higher the stock price and the investors consider the consolidated earnings reported by the companies evidently (Kazeruni, Feshari, 2008). One of the important factors of the effect of consolidated earnings on stock price is such that the reported earnings and earnings forecast help the stock holders to predict the future consolidated earnings as one of the effective factors in determining the stock price. Thus, if consolidated earnings have close relation with the changes of stock price, it can be a good index for valuation by changing the value of stock. The ability of prediction of bankruptcy of the business unit is of great importance both from private investment view and social view (Alior, 994). Based on the importance of consolidated financial statements and using the cash changes in financial statements and the earnings forecast for stock price and stock return, the question is such: Are cash flow and earnings of consolidated operation more information content than cash flow and the earnings from operation of the parent company? Review of literature Now, some motivations as elimination of some fixed costs, coordination of manufacturing stages in production process, applying efficient management and increasing productivity, reduction of risk, rapid achieving to the financial resources, achieving competitive advantages and entering the new markets and using the legal and tax benefits increased the consolidation of business institutions. In combination of business units if the combination leads into the creation of parent company and subsidiary company, the achieving unit (parent) should present consolidated financial statements. The aim of providing consolidated financial statements is providing information on the financial position and financial performance of the parent company and subsidiary companies. Based on the significance of the study in most countries in the world, formulating the accounting standards about presenting the consolidated financial statements is considered more. The information of cash flow can help the judgment of users of financial statements. The information shows the relation between profitability of business unit and its ability to create cash flow and it defines the quality of acquired earnings by business unit. The information of cash flow can be used to control the accuracy of the past evaluations and it shows the relation between the activities of business u nit and its receivable and payments (Naderi, 202). The earnings concept is one of the applied concepts in an economical institution. Based on the various aims of users, various definitions and measurement methods are presented for them. Using earnings for special goals as measuring the management efficiency, company future performance forecast measure or future dividend, the evaluation measure of the success of the companies, tax determination basis, the basis of formulating the company regulations to all people and the evaluation measure of judgment about the assignment of resources by economists for earnings (Clyde, 2007). Beatty et al., 2002 found that in private joint stock companies in which the ownership of them belongs to many people, earnings management is more compared to public joint stock. Bhattacharya (200) believed that a group of capital market activists namely the stock holders in joint stock without adequate financial analysts emphasize on simple indices of earnings. Graham and King (2000) conducted a study on 6 Asian countries and the results of their study showed that there is a strong relation between market stock price and accounting stock price at the end of each fiscal year. Chen et al. (200) found that accounting information in China is dependent upon the market value while these findings are not suitable for the new companies with unsuitable financial reports. Brimbleand Hodgson (2007) conducted some studies in Australia and evaluated the relevance of accounting earnings of the commercial companies of Australia. After the control of market inefficiencies and non-linear trends in data found that earnings relevance was not declining in the past 28 years. Walker (976) investigated exact details on relative importance of consolidated and non-consolidated companies. His findings showed that similar content of the activity and ownership structure of the companies required consolidated financial reports. The information content of consolidated earnings and the report of parent companies were considered by many researchers (Okudaand Shiiba, 2006; Herrmann, 200). Niskanen et al.,(998) found that consolidated accounting earnings can be considered as explanatory variable with high power in determining the changes of stock return and besides the consolidated cash flow can be considered as an incremental measure of information content to cash flow of the parent companies. Abad et al., (2000) studied the information content of consolidated earnings and consolidated cash flows in Spanish companies and the results of their study showed that consolidated earnings and consolidated cash flows have incremental information content compared to the parent earnings and their cash flow. Harris et al., (997) consolidated financial reports didn t present much information about earnings relevance. There are many accounting studies on the effect of accounting information on stock price and stock return to measure their value relevance. 64
3 Hypotheses Hypothesis : The cash flow from consolidated operation has much information content compared to cash flow from the operation of the parent company. Hypothesis 2: The earnings from consolidated operation have much information content compared to earnings from the operation of the parent company. To test the mentioned hypotheses in this study, the following model based on Niskanen et al., (998) was used. Niskanen et al., (998): Where, The adjusted annual return of stock market in year t of company i The earnings changes of the parent company in year t to year t- for company i The cash flow changes of the parent company in year t to year t- for company i The changes of consolidated earnings in year t to year t- for company i The changes of consolidated cash flow in year t to year t- for company i The variable 0, to separate the studied companies based on the adjusted return of stock. By this variable, the companies are divided into two types: The firms consolidated and non-consolidated earnings with the same indicator The firms consolidated and non-consolidated earnings with the different indicator MATERIALS AND METHODS This study is ex post facto design. The aim of the background studies is the evaluation of previous and current position with the actions and reactions of one unit of society or a person or a group. The aim of the ex post facto studies is the evaluation of the causal relation via the study of the existing results and the previous review to find the cause. As the present aimed to evaluate the value relevance of the earnings and consolidated cash flows in stock return, the validity of the test was tested by the justification power of stock return. Study population The study was done during The study population was all the companies listed in TSE meeting the inclusion criteria as: Being listed in TSE before fiscal year No transaction stopping during the fiscal year and it will be profitable. No investment and agency companies The consolidated financial statements are given to the users. Among all the companies listed in TSE, after the limitations and the investigation of the existing data, 8 parent companies were selected and each of them had 4 subsidiary companies. RESULTS The results of Table showed the descriptive indices of the study components. Based on the estimation of the descriptive indices of this variable and significance level of Jarque bera test showing the normality of the observations. It is concluded that the data of response variable (adjusted annual return of market) at first type error level 0.05 followed normal distribution (p=0.3097). The mean of this variable during the study years was 3.02 with standard deviation The negative skewness of the data was close to 0 and it showed that approximate symmetry of the data around their mean. The kurtosis coefficient was 2.34 and it showed that adjusted annual return values of the market had symmetrical distribution with thin tales. The possibility of observing very small or very big values in distribution of the data are low. Mean SD Skewness kurtosis Jarque bera statistics Significance level Table. The descriptive indices of the variables Consolidated Consolidated Parent Parent cash flows cash flow earnings earnings Stock return
4 Before the fit of regression model, the stud of the linear correlation between the variables was considered. To do this, by referring to the normality of the study variables, the estimation of Pearson linear correlation coefficients to evaluate the linear relation between these variables and the results are shown in Table 2. The estimation of Pearson correlation values for these data showed that the adjusted return values of the market have positively significant correlation with the variables of consolidated earnings changes and the parent earnings changes at first type error level There was a positively significant correlation between the values of this variable with the values of parent earnings changes. There was a positively significant correlation between values of this variable and values of parent earnings changes but its relation with the consolidated earnings changes at first type error level 0.05 was not significant. It can be said that the correlation of the mentioned variables was tested alone and if one of the variables is relate to other explanatory variables, its indirect effect via correlated variable on adjusted return of market is possible. Table 2. The estimation of the values of linear correlations of the variables Consolidated Consolidated Parent earnings Parent cash cash flow earnings flows Consolidated cash flow Consolidate earnings * Parent earnings * * 0.58 Parent cash flows * * * Stock return * 0.66 * * 0.52 Stock return Before the fitting of regression models, the fixed or random effects in regression models should be considered. Thus, Hausman test was applied. This test was formed based on the fixed effects and H0 showed the fixed effects and H showed the random effects. Table 3. The evaluation test of fixed and random effects Effect test Statistics Degree of freedom Significance level F test (523,3) Chi-square Based on the significance level test, H0 at first type error level 0.05 is not rejected. It can be said that the model with fixed effects is suitable for the study variables. In the required economical models, the fixed effect models are fitted. To evaluate the information content of cash flow, 0, variable are entered in the model. This variables shows the consistency of the changes of consolidated cash flow values and parent cash flow and as its value when the both variables are positive, it is equal to otherwise it is zero. The results of fitting of regression model between consolidated cash flow, parent cash flow and adjusted return of the market with the dummy variable are as following. Table 4. The evaluation model of consolidated cash flow of the parent company Variable Coefficient Standard error t-statistics Significanc e level Fixed value Consolidated cash flow Parent cash flow Index R Durbin-Watson.987 Adjusted R The sum of error squares F statistics 7.4 Significance level The results of fitting of the above regression model showed that consolidated cash flow didn t have significant effect on adjusted market return while parent cash flow had significant effect compared to the consolidated case. In other words, cash flow from the consolidated operation didn t have more information content compared to cash flow from the parent company. Based on the significance of the dummy variable test, it can be said that this model had similar results for each of the groups with adjusted stock return and the classification of the companies based on the stock adjusted return didn t have significant effect on the results. 66
5 In other words, the fact that the changes of consolidated earnings and parent earnings are different or not didn t have any effect on these results. To evaluate the earnings information content, 0, dummy variable were used. This variable showed the consistency of the changes of consolidated earnings and parent earnings. The results of fitting of regression model between consolidated earnings and parent earnings and adjusted return of market with dummy variable are as: Table 5. The evaluation model of information content of consolidated earnings and parent company Variable Coefficient Standard error statisticst Significance level Fixed Indicator Consolidated earnings Parent earnings R Durbin-Watson Adjusted R The sum of squares of error F statistics Significance level 0.00 The results of regression model showed that consolidated earnings didn t have significant effect on adjusted return of stock market, while the parent earnings had significant effect compared to the consolidated case. In other words, the consolidated operation earnings didn t have much information content compared to the earnings of parent operation. Based on the significance of dummy coefficient test, it can be said that this model for each of the groups with different adjusted stock return had different results and the adjusted return of the stock had significant effect on the type of relation between the variables. CONCLUSION The results showed that consolidated earnings beside the parent earnings didn t have incremental information content to stock market and consolidated cash flow didn t have incremental information content compared to the parent cash flow. These comparisons are useful when each of the above variables are evaluated based on their gender (Based on earnings or cash flow). The results showed that during the study years by considering all the information of the variables, the consolidated cash flow and consolidated earnings of the companies had significant effect on stock market return and they had incremental information content compared to other variables. Based on the difference of the performances of these variables and their information content to stock market return, the overlapping of the variables to each other is considered. The significant correlation between parent cash flow and consolidated cash flow and parent earnings and consolidated earnings showed that when these variables are beside each other (When the main model of the study is tested), consolidated cash flow and consolidated earnings have incremental information compared to the parent cash flow and parent earnings. But these variables were not compared in terms of information against the other variables and they didn t show significant incremental information compared to its similar variables. Based on the results, it is proposed that the investors in their decisions consider consolidated financial statements for being cautious in estimating the investment return. As in the present study, the mean of consolidated earnings changes was smaller compared to the changes of parent earnings and it is estimated by negative sign. In the companies in which consolidated financial statements are provided, these financial statements when the earnings are smaller than the values in the parent company, a criterion for assigning earnings is considered. REFERENCES Abad C, Laffarga MJ, Garcı á-borbolla A, Larra nm, Pin ero JM, Garrod N An evaluation of the value relevance of consolidated versus unconsolidated accounting information: evidence from quoted Spanish firms, Journal of International Financial Management and Accounting. (3): Alivar A Cash flow statement. Tehran. Accounting and auditing research center of audit organization. 4p. Beatty A, Ke B, Petroni K Earnings management to avoid earnings declines across publicly and privately held banks. The Accounting Review. 77: Bhattacharya CB, Sankar S Does Doing Good Always Lead to Doing Better? Consumer Reactions to Corporate Social Responsibility, Journal of Marketing Research. 38: Brimble M, Hodgson A On the intertemporal value relevance of conventional financial accounting in Australia, Accounting and Finance. 47(4): Chen CJP, Chen S, Su X.200. Is accounting information value relevant in the emerging Chinese stock market? Journal of International Accounting Auditing and Taxation. 0():
6 Clyde P, Stickney Financial Accounting; an Introduction to Concepts, Methods, and Uses. South Western Can gage Learning, Canada. Dyvandary A, Zali M Evaluation of the Effectiveness of Smalland Medum Enterprises. Labor and Socity Magazine. 09. Graham RC, King RD Accounting practices and the market valuation of accounting numbers: evidence from Indonesia, Korea, Malaysia, the Philippines, Taiwan, and Thailand, International Journal of Accounting. 35(4): Haqshenas H MA thesis. The evaluation of value relevance of consolidated earnings and consolidated cash flow (The firms listed in TSE). Harris TS, Lang MH, Moller HP. 997Unconsolidated versus consolidated accounting measures: empirical evidence from listed German companies. 20th Annual Congress of the European Accounting Association, Graz. Hellstro MK The value relevance of financial accounting information in a transition economy: the case of the Czech Republic, European Accounting Review.5(3): Herrmann D, Inoue T, Thomas WB The relation between incremental subsidiary earnings and future stock returns in Japan, Journal of Business, Finance, and Accounting. 28(9-0): Kazerouni A, Feshari M. 200.The Impact of Competitive Price andnon-price Indices on the Export of Industrial Sub-Sector: a case of Iran, Quarterly Journal of Quantitative Economics(Quarterly Journal of Economics Review). 5(): Naderi MM Translation and written by investment principles in TSE. Kiomars publications. Third edition. Niskanen J, Kinnuenen J, Kasanen E A note on the information content of parent company versus consolidated earnings in Finland. The European Accounting Review. 7(): Okuda S, Shiiba A An evaluation of the relative importance of parent-only and subsidiary earnings in Japan: a variance decomposition approach, available at: (accessed March 2, 2008). Pakzad A The power of cash flow ratios. Accountant journal p. Pourheidar O, Eslami Q, Safajo M The study of the relation of earnings and book value of the companies listed in TSE. Accounting and auditing journal. 42(2). Walker RG.976. An evaluation of information conveyed by consolidated statements, Abacus. 2(2): Zimmerman JL, Kothari SP Price and return models, Journal of Accounting and Economics. 20(2):
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