Empirical evaluation of accounting income

Empirical evaluation of bill incomeWith the rise of multinational companies and the growth of international investments, there has been an increasing demand for an a posteriori evaluation of write up income number. The glob and embrown determine in 1968 broadens this ara of write up system seek. With the rapid developing of the literature, there are more than 1000 published studys in academic accounting and finance journals in the last thirty years (Kothari, 2001). However, several accounting experts assert that there are some weaknesses in the enquiry of orb and dark-brown. Meanwhile, critics argue that their empirical evaluation contributed to the accounting explore since tardyly mid-seventies. The purpose of this shew is to introduce the strengths of B each(prenominal) and chocolate-browns paper and get word its mould on the development of accounting. This essay leave alone argue that the bound of the paper is non serious, but its advantages are very si gnifi preservet. First, arguments for and against the empirical interrogation are discussed. Then, an evaluation is explored .Lastly, a conclusion is presented.2. The weaknesses of the paperThe major need of the addict and Brown study is to use empirical evidence to see whether the accounting income poem convey knowledge of firms financial performance. They pioneered capital grocerys explore in accounting. However, their study still has some weaknesses.2.1 Un reliabilityThe reliability of their results depends on the sources of information, which may be a potential limitation of the study. Although we are not disputing the reliability of the said sources, they should be investigated. Research should be conducted to document various(a) types of institutions. According to Zhang (2007), the selection of the sample did not include companies meet the spare-time activity four conditions. The first one is the failed union. The second one is a company whose financial year does no t end on the 31st of December. The triplet one is the company that is not recorded in the CRSP database of form expenditure research centers. It also includes the young firm that is not described by the Wall Street Journal. Given those situations, the generality and reliability of their results may be reduced.2.2 LimitationsThe research firmly supposes that some information of stock prices slew be hypothecateed by the earnings. However, the Ball and Brown study did not use a statistical test to ascertain whether there is any residual between earning information and the information reflect in the stock prices.Rayburn (1986) asserts that stock returns run through been statistically compared with cash flows, earnings, and accruals during the 1980s. Aside from providing a formal test, sketchy information of cash flow was utilise in previous research. The succeeding studies used more comprehensiveness expectation models to separate the unanticipated components of earnings, accrua ls, and cash flows, apt(p) that returns in an efficient market only reflect the unexpected components (Livnat et al., 1990).ListenRead phonetically3. The strengths of the paperAlthough the weakness of this paper is obvious, the design of variables and the results of the test admit do outstanding contributions to research of accounting income.3.1 Ingenious design of variablesAfter identifying the research themes, Ball and Brown selected the most representative accounting income total to flyer the information content. Considering that administerholders are more concerned about EPS and net income, Ball and Brown used them as variables. To determine the information content of the accounting income, they used market efficiency possibility and the capital plus price model as references.According to the efficient market hypothesis, the authors maintained that discernible stock price is fluctuant and linked with information. This seat mean that accounting income numbers are useful . The key to determining the relationship between accounting income and stock price is to distinguish the security prices of a particular company as well as all the separate companies. Therefore, the authors built two models of market expected return to examine how the market reacts to accounting income numbers.Ball and Brown separated factors that affect earning into two different kinds specific factors and system factors. administration factors affect all companies, thus, the wasted of one company and other companies can be linked with each other. If the link is suitable, then stability can be shown using a fixed function, enabling us to get the income conditional expectation of one company based on other companies data. Thus, changes in the unexpected surplus of earning can be estimated by shrewd by the changes in both actual income and conditional expectation. The authors defined the difference as the gain of current information. At the same time, they assumed that the chang es in policy and corporate have been enacted before the first friendship. Thus, the influence of macroeconomic and policy changes can be estimated jointly.The authors initially used the Ordinary to the lowest degree Squares (OLS) to estimate the linear regression coefficient and intercept of samples annual income changes and average income changes. Secondly, the changes in the market income average were used as independent variables and included in the regression model to calculate the expected pass judgment of income changes. Finally, the changes in the value of unexpected earnings (prediction residual) referred to the actual value of the earnings change minus the change in earnings expectations. Therefore, market effect was removed from the estimation of expected surplus, which means the authors did not take system factors into account.Similarly, the factors affecting the contact of no stock or stock returns can still be separated into two factors system factors and specific factors. First, the authors used capital asset pricing model to separate the system factors and from non-system factors, then calculated the deviation of actual rate return and expected stock return. Secondly, Ball and Brown calculated the companys stock return residuals ( brachydactylous returns). Given that markets are efficient, stock prices will adjust quickly and effectively about the new information, so residuals can show the reach on stock prices of new information. To test the cogency of statistics, Ball and Brown used an alternating(a) model- straightforward model. In this model, an alternative variable is the expected surplus for last years actual surplus. The naive model does not eliminate the market effects, but verifies the earnings per share targets.3.2 Remarkable resultsThis paper distinguished expected changes and unexpected changes in accounting incomes to estimate the atypical return and changes in unexpected accounting incomes. In addition, it theorized that when the surplus prediction demerit is negative, it is both advantageous and disadvantageous. This paper presented the hypothesis that if the accounting income numbers could be linked with stock prices, then the contract of accounting income numbers could result in changes in the stock returns. In the empirical test, the authors defined the month of annual field of study as 0, API representing the abnormal performance index of month M. In the process of calculating the API, the changes in unexpected earning are first separated into two groups (positive and negative), and then all samples are calculated together. Ball and Brown thought that if accounting income is tie in to stock returns, it can be assumed that if the changes in unexpected surplus are positive, then API is boastfulr than 1 if they are negative, then the API is less(prenominal) than 1. In the combined sample, API is close to 1.Ball and Brown thought that annual income report can provide new information however, i t cannot be transfer in time, because most of its content comes from various sources (interim report and non-accounting information, annual accounting report is only one of them) .The authors also found that after the promulgation of the annual report, API has a tendency to drift on, that is, revenue projections residual error signal and the relationship between stock returns in the annual report may be continued for two months. After analysis, which may be caused by the transaction costs, and excluding the impact of transaction costs, the market reaction to the numbers tends to be unbiased.4. EvaluationAt first glance, one weakness of this empirical research is the limitation of the sample which may decrease the generality and reliability of the results. However, the selection of the sample was similar to the tests used in related literature, which could adept to consistent results if used the same way on other samples.The weaknesses of the paper also include the limitation of t he statistical tests. Nonetheless, it had a significant impact on later research. In 1968, the Ball and Brown study shows that accounting earning announcements contain information content. In the meantime, they link the sign of monthly abnormal stock return with the sign of the previous years earnings change. start with Ball and Brown, many studies began to compare alternative accounting performance measures, such as historical cost earnings, current cost earnings, residual earnings, and operate cash flows with stock returns. Under the similar circumstances, the Ball and Brown study also facilitated Watts and Zimmermans positive accounting theory in the late 1970s (Watts and Zimmerman, 1979). As Watts and Zimmerman (1990) point out, most accounting research since Ball and Brown has been positive, and the fictional character of accounting theory is no longer normative.According to Kothari (2001), Ball and Brown heralded the positive-economics-based empirical capital markets resea rch in the late 1960s. The supposititious and methodological innovation of the early accounting research was founded by the concurrent developments in economics and finance. Without this historical exploring of Ball and Brown in early capital market research, even seasoned researchers may have to detour or lose continuity.In addition, this paper analyzes the insufficiency of theoretical studies using empirical testing to find out whether the accounting income numbers are useful. It initially provides reliable evidence that stock markets can influence annual reports. Then researchers began to do a lot in reflect of stock market. Furthermore, the method used is also applicable to a large number of accounting and financial issues, including dividend announcements, earnings announcements, mergers and acquisitions, and investment spending.5. ConclusionThis essay has discussed the weaknesses and strengths of the empirical evaluation of accounting income numbers by Ball and Brown. Althoug h this research has some limitations, the merits far outweigh the disadvantages. It preceded the positive-economics-based empirical capital markets research of the late 1960s. The theoretical and methodological innovation of the early accounting research was founded by the concurrent developments in economics and finance. Therefore, it is suggested that this research plays a great role in the development of accounting .In this essay, only a few strengths are mentioned the ways of putting these benefits into practice need further exploration.