This paper examines the functional form of earnings and stock prices on US and Finnish stock markets. Although the functional specification of the components of financial ratios based on purely accounting numbers has received considerable attention, the functional form of earnings and stock prices has not been investigated carefully enough. This investigation is, however, important because of the common use of E/P ratio in financial statement analysis. The empirical evidence provided by this study indicates that the proportional relationship between earnings and stock prices is rejected in both countries. In addition, it is discovered that this deviation from proportionality is a major factor producing the so-called E/P anomaly in these two countries.

On the functional form of earnings and stock prices: international evidence and implications for the e/p anomaly

This paper examines, in a Canadian context, the effect of short sales regulation on the risk-return relationship. It shows that, theoretically, the opportunity cost induced by short sales regulation is positively related to the dispersion of agents' beliefs and negatively related to the security's liquidity level. The model is tested over the sixty-month period from January 1985 through December 1989. All the 13,079 observations are pooled into a time series cross-sectional model. The results corroborate that a negative linear relationship links expected risky asset returns and the divergence of agents' beliefs. This negative relationship is consistent with the presence of opportunity costs resulting from short sales regulation when return beliefs are heterogeneous. However, the negative relationship between security returns and dispersion of beliefs is essentially confined to illiquid securities, that is, those monitored by a small number of analysts.

Heterogeneous Expectations, Short Sales Regulation, and the Risk‐Return Relationship

This study aims to empirically investigate the association between degree of leverages, operating and financial, and firm value in the context of India, one of big ten emerging markets (Garten, 1997) This study examines this association for 231 manufacturing firms listed in National Stock Exchange (NSE) in India over a period from 2001-2002 to 2010-2011 The independent variables, degrees of operating and financial leverage, and a market price-based dependent variable, called price-earnings ratio as a proxy of firm value, are taken to examine this relationship by using standard ordinary least square regression models at the levels of individual firm and portfolio of firms The findings of this study show a statistically significant negative relationship between firm value and degree of operating leverage and a statistically insignificant relationship between firm value and degree of financial leverage both at the levels of individual firm and portfolio of firms Using the data from a country like India, one of fastest growing emerging markets in the world, this study provides an important insight on the effect of leverages on the firm value, the association between independent accounting variables and stock price-based dependent variable, to the practitioners, the scholars and the finance managers

/pdf/association-between-degree-of-leverages-and-firm-value-358og4f1ua.pdf

Association between Degree of Leverages and Firm Value

The inquiry, do investors value the accounting numbers in the marketplace, is always of considerable interest for the scholars and the practitioners in the context of developed and emerging markets. However, many research studies on this topic have not been examined in the Indian context; therefore the present study claims the inquisitiveness of this inquiry to be explored in the context of India. India is one of the biggest ten emerging markets (Garten, 1997) and the structures of business organizations in the emerging or developing markets are different from those in developed markets (Sarkar et al. 2008). A relationship between earnings, an accounting number, and the value of common stock was extensively hypothesized by valuation theory (Beaver, 1968). The valuation theory and the theory of decomposition of systematic risk explicitly into the degrees of operating and financial leverage are the bases of this study. This valuation theory takes the point of view of equity investors to empirically examine the value relevance of accounting information (Beisland, 2009). Mandelker and Rhee (1984) presented an alternative theory of decomposition of systematic risk by explicitly introducing the degrees of operating and financial leverage to the theory of systematic risk decomposition of Hamada and Rubinstein. The present study also takes theory of the capital asset pricing model (CAPM) developed by Sharpe (1964), Lintner (1965), and Black (1972); theory of decomposition of systematic risk developed by Hamada (1972) and Rubinstein (1973); and the capital structure theory developed by Modigliani and Miller (1958). Although, there is an extensive research available on the value relevance of accounting information; however limited work is done on the value relevance of the degrees of leverage, particularly in the Indian context. The degrees of leverage in financial literature are of two types, the degree of operating leverage (hereafter DOL) and the degree of financial leverage (hereafter DFL). With the use of the concept of elasticity Mandelker and Rhee (1984) and Ang and Peterson (1984) initially established a time-series regression approach to estimate DOL and DFL. DOL is defined as the percentage change in profit or earnings before and tax (hereafter PBIT or EBIT) relative to a given percentage change in sales (Prezas, 1987; Elangkumaran and Nimalathasan, 2013). DFL is defined as the percentage change in profit after tax (hereafter PAT) relative to a given percentage change in EBIT (Mandelker and Rhee, 1984). The primary objective of this study is to empirically examine the value relevance of DOL and DFL, the important accounting numbers, for 230 manufacturing firms listed on National Stock Exchange (NSE) of India over the period of ten years from the financial year 2001-2002 to 2010-11 including the recessionary period. In other words, the combined effects of DOL and DFL on stock returns, systematic risk, and firm value are to be empirically investigated for the sample listed manufacturing firms in India over the period under study. The standard ordinary least square regression models at the levels of individual firms and portfolio of firms are employed to present the empirical findings for achieving the stated objectives of this study. The empirical findings support the hypothesis that the degrees of operating and financial leverage are value-relevant. Thus, the accounting numbers or focus variables of this study, DOL, and DFL, do significantly affect the stock returns over long windows. However, controlling for firm size and ROA does not influence the conclusion of an impact of degrees of leverage on the stock returns. The results also indicate that the investors historically earn higher returns if the firms operate at high DOL and DFL and vice-versa. This means the principle 'higher the risk, higher the possibility of earning returns' holds good. The findings partially support the hypotheses that DOL and DFL do influence the systematic risk and the firm value. DFL is found positively related with the systematic risk, and an insignificant negative relationship is found between DOL and the systematic risk. DOL significantly positively affects the firm value over the long-window; however, DFL and the firm value are not associated. This means that the firm value is independent of its financial risk. Moreover, controlling for firm size and return on assets (hereafter, ROA) does improve the relationship of DOL and DFL with the firm value since the statistical significance of firm size is found in explaining the firm value. However, ROA has no influence on the firm value. In other words, the findings of the present study suggest that high DOL and DFL leads to high returns to the firms. Also, high DFL leads to high systematic or market risk to the firms and high DOL leads to high firm value. These results indicate that DOL and DFL are relevant accounting numbers for the shareholders’ value. Though, leverage is considered to be a two-edged sword – just as a firm’s profits can be magnified, so too can the firm’s losses (vanHorne and Wachowicz, 2010). The implications of value relevance of DOL and DFL do not suggest the firms to just increase the level of DOL and DFL so as to fetch higher returns to the firms. The findings simply suggest the consideration of usefulness of DOL and DFL for optimizing the financing and investment decisions of the firms. The above empirical findings of this study are not only considerably worthy of scholarly attention but also relevant for various interested participants using accounting numbers for decision-making in the marketplace. There are several indications pointing towards the need for this study. First, the value relevance of the degrees of leverage found in the present study is the enrichment to the value relevance literature in the Indian context. Second, the studies in the Indian context examined the value relevance of several independent variables (e.g. earnings, accrual earnings, book value per share, earnings per share, cash flows from an operation, changes in earnings and book value). However, there is a lack of research in the context of India that takes two important accounting numbers, DOL and DFL, as independent variables to examine their value relevance. Therefore, these two accounting numbers, DOL and DFL, of this study are added to the list of variables explored empirically in the previous research studies. Third, this study finds that the firms operating with the high degrees of leverage historically earn higher returns than the firms with small degrees of leverage. This means high risks are compensated. Fourth, the applicability of various well-published theories established in the developed markets has been reexamined in the context of an emerging market, called India. Fifth, stock returns and firm value across industries are statistically not significant. However, systematic risk is statistically found significant across industries. This indicates the different industries are exposed to different market risk depending upon their business models, investment and financing decisions. Sixth, the present study provides an important insight to the practitioners, the researchers, the finance managers and the investors for the significance of accounting numbers in the context of India, one of the fastest growing emerging markets in the world. The firms may include the importance of the degrees of leverage in its annual reports. Moreover, this study can also be useful for corporate or security valuation in case of mergers and acquisitions. However, it is to ensure the key sources of valuable accounting information to the investors who can influence the process of security valuation (Fiador, 2013). Further, this study is limited to the NSE-listed manufacturing firms in India for a period from 2001-2002 to 2010-2011 including the recessionary period that could affect the empirical results. Moreover, the sample firms under this study are 230 only. The present study is limited to an emerging market, the India. The changes in DOL and DFL over time are not discussed as the estimation of year-wise DOL and DFL is not attempted in this study. The application of a panel data or pooled regression method is possible to test the proposed hypotheses if year-wise DOL and DFL are available. However, the usefulness of this study cannot be undermined due to the above limitations since the present study extends the efficacy of well-established theories (e.g. valuation theory; theory of risk decomposition; capital asset pricing model theory; capital structure theory) developed previously in the literature. Since this study is based on these wellaccepted theories and reliable methodologies; hence its findings are considered relevant in the Indian context. Further, these limitations are not so critical that could significantly jeopardize the results of the present study. Finally, this study is summarized below.

Value Relevance of Degree of Leverages and its Impact on Systematic Risk An empirical study on Indian manufacturing firms

A ‘two-stage growth’ discounted cash flow (DCF) model is built to test whether changes in the underlying market fundamentals help to explain movements in stock prices. Empirical results on two samples of US and EU stocks show that the ‘fundamental’ earning price ratio (E/P) explains a significant share of cross-sectional variation of the observed E/P, this impact being stronger in the US market. It is also found that: (i) the fundamental component of the E/P has superior explanatory power than simpler measures of expected earnings growth; (ii) ‘non-fundamental’ components, interpreted as signals reducing asymmetric information (such as firm size, the number of forecasts and the chartist momentum), mitigate the role of the fundamentals; (iii) current deviations from the fundamentals are affected by ex post adjustment of publicly available information in the EU sample. It is argued that differences in regulatory environments and in the composition of investors between the US and EU financial system...

Deviations from fundamentals in US and EU stock markets: a comparative analysis

(1989). Analyst Forecasts and Price/Earnings Ratios. Financial Analysts Journal: Vol. 45, No. 2, pp. 60-62.

/pdf/analyst-forecasts-and-price-earnings-ratios-1jouy0vq53.pdf

Analyst Forecasts and Price/Earnings Ratios

Handle everyday research tasks with reliable, citation-backed results

Your personal Research Agent to handle research tasks with citation-backed results

Popular Tasks used by Researchers

How can I help with your research?

Meet SciSpace

Get more enhanced response by uploading the PDFs you want me to reference.

No relevant PDFs in your library

SciSpace is the AI research assistant for academics. Run systematic literature reviews on 280M+ papers, and write papers with cited sources. Trusted by 1M+ students, PhDs & researchers.

SciSpace | AI for Research

Analyze PDFs

Code & Manuscripts

Funding & Grants

Literature & Patents

Medical & Clinical Data

Systematic Review

Visualize & Present

Web & Data

Build a Google Scholar-like website for your research.

Build a website

Create charts and images for your research

Create a Chart

Write a paper for submission to a journal

Draft a manuscript

Patent Search

Design eye-catching scientific posters in minutes.

Scientific Poster Generation

Systematic Literature Review

One task is running at the moment. Your messages will be shown right after.

Drag and drop or click here to browse

Loved by <highlight>1 million+</highlight> researchers

Extract a list of specific topics and their sources from unstructured text

Topics

Compare and analyze relevant papers that matches with your search

Papers

Get insights from PDFs and bookmarked papers from your library

My library

Recent searches

Try searching for:

Catch AI-generated content in scholarly and non-scholarly content

{ai} Detector

Ai Writer

Get PDF Summaries, highlighted text explanations 

Chat with PDF

Effortlessly create in-text citations and bibliographies in APA and 2,500 other formats

Citation generator

Get explanations, summaries, and answers on academic papers

Ease up your research workflow with {scispace}'s cohort of exciting AI tools

Elevate your academic writing skills and convey your ideas the way you want

Paraphraser

Explore our range of reading and writing tools

Your file is being prepared and should be ready in a few minutes. If it's a large file, it might take a bit longer. You can close this window, and we'll email you the file when it's done.

You have reached a maximum limit of <strong>{limit}</strong> columns in the table. Remove at least <strong>1</strong> column to add or create another one.

Timothy Sullivan

Author Tools

Chat about Author

Papers

Analyst Forecasts and Price/Earnings Ratios