Market Uncertainty and the Value Relevance of Earnings
Asian Tax Journal Vol. 23 No. 3 (2022), pp. 69-92
Abstract
This study examines whether market uncertainty affects the value relevance of earnings. Uncertainty reduces consumer demand, aggravates the collectibility of receivables, and leads to a larger investor reaction to negative earnings news. With increased likelihood of firms reporting losses or suffering from financial instability, and also with stock price valuations that are affected by investor fear as opposed to firm fundamentals, we expect lower value relevance of accounting information under periods of high uncertainty. Using 25,900 observations from year 2005 to 2020, we find the following results. First, we find that the value relevance of earnings is lower under high uncertainty. In contrast, the value relevance of book value is not significantly different during periods of high uncertainty. Second, to examine whether earnings quality affects the relation between uncertainty and the value relevance of earnings, we have divided the sample into subsamples of high and low absolute abnormal accruals. While we find negative effect of uncertainty on the value relevance of earnings for the subsample of high absolute abnormal accruals, we do not find significant relation for the subsample of low absolute abnormal accruals. This result indicates that the negative relation between uncertainty and the value relevance of earnings is driven by firms with low earnings quality. Third, we have also divided the sample into subsamples of high and low foreign ownership. We find that the negative relation between uncertainty and the value relevance of earnings disappears for firms with high foreign ownership. This result indicates that foreign investors play a monitoring role over the managers, restrict opportunistic earnings management, and thereby alleviates the negative effect of uncertainty on the value relevance of earnings. Value relevance of earnings has been an important topic in accounting literature. By showing that the value relevance of earnings is affected by market uncertainty as well as firm characteristics, we provide implications for researchers, investors, and regulators.
Keywords
- Market uncertainty
- value relevance of earnings
- earnings quality
- foreign investors
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