Changrae Park, Faculty of Accounting Department, Gangneung-Wonju National University, South Korea.

Transcription

1 The Stock Price Relevance of Accounting Information for the Companies Designated as Issues for the Administration according to the Causes of Designation Changrae Park, Faculty of Accounting Department, Gangneung-Wonju National University, South Korea. Abstract The purpose of this research is to examine the stock price relevance of accounting information for the companies designated as Issues for Administration in the KOSPI market of South Korea. First, the value relevance of accounting information was compared between the designated companies and non-designated companies from five years prior to designation. Second, the value relevance of accounting information was compared according to the causes of designation- financial causes and non-financial causes. The value relevance of accounting information was analyzed by the basic Ohlson model and the extended Ohlson model, which includes debts ratio and size as additional variables to the basic Ohlson model. The 159 designated non-financial firms are sampled out of the firms listed on the KOSPI between 2003 and The stock price relevance of designated companies which were disclosed as Issue for Administration in the Korea Investors Network for Disclosure System ( was compared with that of the non-designated companies(n=7,081). For the non-designated companies, the accounting information (EPS, Book Value, Size, and Debt ratio) has significant effect on the stock price during all the years, and the debt ratio affects the stock price in the reversed U-shape. However, for the designated companies, the basic model was insignificant in t-5 and t-4 year, and the accounting information had limited effects on the stock price with the exception of the size. The value relevance of accounting information between the designated companies and the nondesignated companies was different. When the value relevance of accounting information was analyzed depending on the causes of designation, the value relevance of accounting information was slightly different between the financial causes group and non-financial causes group. The debt ratio has no effect on the stock price in both groups while the size has significant effect in both groups. However, the EPS and Book Value showed difference between the financial causes group and the non-financial group. Considering these results, the value relevance of accounting information is different in the designated companies and the non-designated companies, and the value relevance of accounting information also varies depending on the cause of designation. Key Words: value relevance of accounting information, Issue for administration, KOSPI market in South Korea, Ohlson Model, EPS, Book value, size, debt ratio JEL Classification: G32, G33, M41 1

2 1. Introduction There are two kinds of stock markets in Korea - KOSPI and KOSDAQ. The companies listed in the KOSPI are larger in size and relatively safer than those listed in the KOSDAQ. However, the companies listed in the KOSPI also face the risk of delisting. Therefore, the KOSPI market has regulations to protect the investors. One of them is the Issue for Administration. The Issues for Administration is disclosure system which discloses that the designated company is in danger of being delisted. Therefore, it notifies the possible danger to the investors and bestows certain amount of time to resolve the designation causes for the designated companies. Initially, the causes of designation were mainly limited to the risks of bankruptcy. Later, the non-financial causes such as violation of disclosure rules, lack in liquidity, violation of governance structure requirement were added. There exist distinctive informational characteristics of the designation in the Issues for Administration. Moreover, the designation of Issues for Administration is different from corporate failure. However, there are few researches about the issues for administration, and this topic has been included in firms failure research rather than separate. According to the Ohlson model (1995), the value of a firm can be evaluated by accounting information - book value and earnings. There are abundant researches which examined the value relevance of accounting information. The early researches mostly focus on the extent of stock price relevance of the book value and the earnings, its changes over the years, and the differences of relative stock price relevance between book value and earnings (Collins et al, 1997; Burgstahler and Dichev, 1997). Researches comparing the stock price relevance and its change expended to the comparison among the industries which differ in the composition of intangible assets (Kenner, 2011), and also to the effect of the financial health on stock price relevance of accounting information (Barth et al, 1998). This research examines the value relevance of accounting information of the designated companies according to the causes of designation from five to one year prior to the designation. The detailed purposes of this research are as follows; First, this research compares the stock price relevance of the basic model and the extended model between the non-designated companies and the designated companies. 1 Second, this research compares the stock price relevance of the basic model and the extended model according to the designation causes financial causes and nonfinancial causes. 1 In this research, the basic model comprises the book value and earnings as independent variables, and the extended model adds two more variables financial health and firm size to the basic model, and the dependent variable is the stock price of the firm. 2

3 2. Literature Review 2.1 The KOSPI Regulations of Issues for Administration The company which is under the risk of delisting is designated as Issues for Administration. Therefore, designated companies are the ones which suffered from severe financial distress caused by bad operation performance, lack of liquidity due to the infrequent stock trading, business suspension, violation of governance structure requirement, and etc. The Issues for Administration affects both the investors and the companies. It announces the delisting risk of designated company to the investors in order to call attention to the investment decisions. Furthermore, it imposes certain period of time for the designated company to resolve the problem instead of delisting it immediately. Current KOSPI market states twelve designation causes. Those can be categorized into four groups depending on their characteristics (see Table Ⅰ). The designation information is disclosed through Korea Investors Network for Disclosure System ( The designated companies stocks are banned credit trading, and are no more allowed to be used as substituted securities. The stock trading method in market also changes. Thus, being designated as Issues for Administration imposes substantial restrictions on stock trading which leads the deterioration of the corporate value in the market. Type of Cause Financial causes Non-Financial causes Table 1: The Types of causes of Issues for Administration Causes Impairment of capital Shortage in sales limit Application for reorganization procedure Application for bankrupt Unsatisfied audit opinion Un-submission of periodic report Violation of disclosure regulations Fall short of distribution of shares Violation of governance structure Suspension of business Shortage in trade volume Shortage in stock price market capitalization requirement 2.2 Prior Researches on the Issues for Administration The designation of Issues for Administration is studied as a part of corporate failure, and stock market regulations, such as the Issues for Administration, are only valid under the district of jurisdiction. For these reasons, the researches on the designation of Issues for Administration, which reflected the idiosyncrasies of Korea, have been delineated to the domestic stocks, and among them, merely few focuses solely on that issue. S. Shon and M. Oh (2008) examined the effect of accounting information on stock valuation of the Issues for Administration in Korean stock market. They insisted that even 3

4 though the financial causes were included in the designation of Issues for Administration, the designation did not always indicate the uselessness of accounting information of the designated companies. However, in the market, designation itself could raise the doubts about the reliability of the accounting information which was disclosed by the designated company. If accounting information is reliable, the market reacts to it. Thus, if the reliability of the designated companies accounting information was lower than the other companies, the market reaction of the designated companies accounting information becomes less than that of the others. They examined whether the reliability of accounting information differs depending on the designation cause at the time of designation and release. They measured the market reaction by CAR. According to the results, the CAR for unexpected earnings declined after the company was designated as the Issues for Administration, and increased when it was released from the issues. It had tendency of having larger reaction to the accounting information when the causes of designation were related to reliability of accounting information. However, the effect was not statistically significant. T. Kim and C. Eum (1997) examined the stock returns and market risk of the designated companies for 13 months prior to the designation. As a result, the designated companies showed significant decrease in stock returns and higher market risk. Based on these results, they asserted that stock return and market risk may be used to predict the possibility of the designation. However, even though the causes of the designation included both the financial and non-financial causes, they regarded the designated companies as financially distressed. M. Kim (2004) analyzed whether the causes of the designation affected the stock return. He classified the causes of the designation into two factors (financial and non-financial), and analyzed each group s stock return changes before and after the designation. The results showed that in the case of financial causes, the stock return was significantly different from the market return while the stock return of non-financial causes was not. I. Kim (2005) examined the financial characteristics of the designated companies. He reviewed whether the designated companies were relatively weak in financial health, and reviewed the changes in financial status. He compared changes in financial status between the designated company and the non-designated company of similar in size and in the same industry from five years prior to the designation. As the results of the comparison of profitability, growth, stability, liquidity, and activity ratios, the designated companies showed the differences in profitability, stability, liquidity, and activity ratios, but the growth ratios were not different. However, his study simply compared the designated and non-designated companies without regarding the causes of the designation. Park (2015) examined the financial characteristics of the companies designated as Issues for Administration according to the causes of designation from five years to one year prior to the designation. The results showed that the designated and non-designated companies 4

5 showed the significant difference in profitability and stability while not in the activity and growth. The financial characteristics were also different depending on the causes of designation. The effect of designation of Issues for Administration in Korea on intra-industry information transfer (Pyo, 2002), and on audit hours and audit fees (Kwon, et al., 2013) also have been examined. 2.3 The Value Relevance of Accounting Information According to the Ohlson model (1995), the value of a firm is the weighted average of the net book value and the earnings. In addition to these, Ohlson also included other information as the valuation factors. The firm s characteristic factors may be included in this other information. Therefore, the researches on the value relevance of accounting information are extended to include the firm characteristic variables such as fair value of fixed assets (Aboody et al, 1999), intangible assets (Klock and Megna, 2000), and R&D expense (Lev and Sougiannis, 1996). Also, another stream of researches studied extended model that includes variables such as the firm size, financial structure, and the audit quality (Barth et al, 1998; Hayn, 1995; Collins et al, 1997). Since 1980s, the firm size has been regarded as an important factor in valuation research. However, the size effects were not consistent. Some show the effects on the value (Banz, 1981; Hayn, 1995), and others do not (Dichev, 1998; Shumway and Wather, 1998). Debt is a major financing source of a company. Generally the debt financing not only has an advantage such as tax shield and management incentives for value creation (Palepu et al, 2013), but also costs financial distress. The effect of the debt ratio on the firm s value also does not show consistent results. Some studies showed the positive effects (Jensen, 1986; Stulz, 1990), and others showed negative effects (Mayers and Majluf, 1984; Friend and Lang, 1998). Also, some results showed non-linear (reverse U shape) relation between the debt ratio and the firm s value (Margaritis and Psillaki, 2010). 3. Methodology 3.1 Research Questions Early mainstream researches on the value relevance of accounting information based on the Ohlson Model focused on the stock price relevance of net income and net book values. Later, firm s financial characteristic variables were added to the Ohlson model. So the model extended to include not only earnings and book value, but the firm characteristics variables such as firm size, leverage (debt ratio), and industry. First, this research compares the value relevance of accounting information between the designated companies and the non-designated companies. From five years prior to the designation(t-5) to the one year prior to the designation (t-1), each year s value relevance of 5

6 accounting information are compared between the designated companies and the nondesignated companies. Second, this research examines whether there is any difference in the value relevance of accounting information depending on the causes of designation. There are various causes of designation, and the financial characteristics of designated companies show differences even three to four years ahead of the designation. When the causes of designation are the impairment of capital or the on-going losses from continuing operations, designation is the result of poor performance of relatively long periods. On the other hand, when the causes of designation are the violation of governance structure or shortage of trade volume, it is the result of relatively short termed factors. Therefore, in these two different cases, the value relevance of accounting information may be different. So the value relevance of accounting information of designated companies may vary according to the causes of the designation 3.2 Research Method This study compares the value relevance of accounting information between the designated companies and the non-designated companies, and compares the value relevance according to the causes of designation. Using stock price and financial statements information from five years prior (t-5) to the designation to one year prior (t-1), the value relevance of accounting information for the designated companies is calculated and compared with the ones of the non-designated companies in the same year. As for the causes of the designation, twelve KOSPI market regulations are reclassified into two types financial causes, and nonfinancial causes (see Table Ⅰ). 3.3 Research Model This research used two models the basic model, and the extended model. The basic model is the conventional Ohlson model which uses the earnings and net book value as the explanatory variables. The extended model includes the size and the debt ratio in addition to the basic model. In some prior studies, the debt ratio showed non-linear relation - reverse U shape (Margaritis and Psllaki, 2010). Therefore, in this research, the debt ratio is regarded as linear and non-linear form in Extended model. The models for the analysis are as follows. Basic Model: P it = α 0 + α 1 EPS it + α 2 BPS it + ε it (1) Extended Model: P it = γ 0 + γ 1 EPS it + γ 2 BPS it + γ 3 DEBT it + γ 4 (DEBT it ) 2 + γ 5 LNSIZE it + ε it (2) P it : Firm i s per share price at the end of March year t+1 EPS it : Firm i s earnings per share for period t DEBT it : Firm i s debt ratio at the end of period t LNSIZE it : Firm i s ln(stock price*common stock outstanding) at the end of period t In this research, the stock price is measured at the end of the March in the next year in order to use the stock price that reflects the year t s financial statements. The earnings is 6

7 measured by simple EPS of period t and the net book value is measured by (total capital total par value of preferred stock)/common stock outstanding at the end of period t. The debt ratio (DEBT) is measured by the (total asset total capital)/total capital. The size (LNSIZE) is the natural log of total market value of common stock. In order to the control the effect of outliers, all the variables are winsorized by 1%. 3.4 Data The samples are selected from the non-financial firms which were listed on the KOSPI between 2003 and 2013 and of which the financial statements data can be extracted from NEW KIS-VALUE Ⅲ database. Among the samples, the designated companies are the firms which were disclosed as Issue for Administration in the Korea Investors Network for Disclosure System ( The 7,240 cases are sampled out of the firms listed on the KOSPI from 2003 to Among the samples, the non-designated companies are 7,081(97.80%), and the designated companies are 159(2.20%). Among the designated companies, the companies designated by financial causes are 68(42.77%), and the companies designated by non-financial causes are 91(57.23%). Table 2: The distribution of samples by year and designation YEAR Non- Designation Causes of the designation designation Sub total (%) Financial Non-Financial Causes Causes Total Total 7, , Results and Discussion 4.1 Descriptive Statistics of Variables The descriptive statistics are presented in [Table 3]. The means and standard deviations of stock price have increased from t-5 to t-1. And the means of EPS has increased from t-5 to t-2, however, decreased in t-1. This may be the influences of designated companies poor performances. The book value also has increased in all years. The debt ratio has declined along the time passes. The debt ratio of t-1 was In Korea, many companies have a policy to reduce the debt ratio after Asia financial crisis in Because the data in this research started from 1998, the period t-5 of 2003 samples, the 7

8 debt ratio may showe decrease. The size, which was measure by the natural log of total market value of common stock, also has increased along the time passes. This may be the result of the stock price increase and the expansion of businesses in Korea after Asia financial crisis in Table 3: The descriptive statistics of the variables YEAR Variables t-5 t-4 t-3 t-2 t-1 mean std mean std mean std mean std mean std Price 15,841 36,929 17,897 41,426 21,083 51,429 24,238 59,105 26,726 64,284 EPS 1,597 8,661 1,967 8,100 2,161 7,982 2,275 7,735 2,021 24,400 BV 26,583 46,565 27,418 49,320 28,422 51,980 30,031 56,020 31,885 61,517 Debt Size Price : The common stock price of the end of 3 month after fiscal year end. return on equity EPS : Simple earnings per share BV : The book value per share Debt : Debt ratio Size : ln(total market value of common stock) 4.2 The Value Relevance of Accounting Information in Basic Model [Table 4] shows the result of regression analyses of basic model for each sample group. The coefficient of determinant of non-designated group has increased from t-5(50.88%) to t- 1(67.98%). In all years, the regression coefficients of EPS and BV is positive and significant at α=0.05. This means that both the EPS and BV have significant effect on the stock price and their explanation power of stock price has increase along the time passes. The coefficients of determinant of designated group have increased drastically. In the year t-5, the coefficient of determinant was 29.25% which was 57.49% (29.25/50.88) of that of non-designated, and even though the coefficient of determinant in t-4(58.42%) of designated group was higher than the non-designated group, it was not statistically significant. Since the t-3, designated group s coefficients of determinant were higher than the nondesignated group. However, the coefficients of EPS were insignificant from t-5 to t-2. Although the coefficient of EPS in t-1 was significant, the negative sign of coefficient was conflicting with common sense. The coefficients of BV were significant except in the year t-4. When the designated group was analyzed according to the causes of designation, the results were different between the two sub-groups. In the case of financial causes, the coefficient of determinants has increased from t-5 to t-2, and decreased in t-1. However, the coefficient of determinants was smaller than that of the non-designated group except in t-2. In addition to that, the coefficient of determinant was insignificant in t-5 and t-4. The coefficients of EPS were insignificant in all the years, and the coefficients of BV were insignificant in t-5, t-4. These results showed that in the cases of the designation due to the 8

9 financial causes, the earnings had no influences on the stock price from the t-5, and the book value had no effect on the stock price in t-5 and t-4. Therefore, the value relevance of accounting information was restricted to the case of the designation due to the financial causes. In the case of non-financial causes, the coefficient of determinants also has increasing tendency from t-5 to t-2, and decreased in t-1. The coefficient of determinants were larger than that of the non-designated group except in t-5, and were larger than the financial causes group during all the years. The coefficient of determinant was also insignificant in t-5 and t-4. The coefficients of EPS were insignificant in all years but t-1, and the coefficients of BV were insignificant in t-4. These results showed that in the cases of the designation due to the nonfinancial causes, the earnings had no effect on the stock price from the t-5 to t-4, and the book value had no effect on the stock price in t-5 and t-4. Therefore, the value relevance of accounting information was also restricted to the case of the designation due to the nonfinancial causes, and the value relevance of accounting information was different from the financial causes. According to the analyses of basic model, the value relevance of accounting information is different between the non-designated companies and the designated companies. Especially, the EPS is clearly different between two groups, and the value relevance of accounting information between the causes of designation also differs. Non-Designation Designation All Financial Causes Non Financial Causes Table 4: The value relevance of basic model Time t-5 t-4 t-3 t-2 t-1 EPS BV R 2 (%) EPS BV R 2 (%) EPS BV R 2 (%) EPS BV R 2 (%) The cells are graded if the White heteroskedastictity constant coefficients are significant at α=0.05 The cells of R 2 (%) are graded if the F-value of regression is significant at α=0.05 9

10 4.3 The Value Relevance of Accounting Information in Extended Model [Table 5] shows the result of regression analyses of extended model for the each sample group. The extended model includes the size and the debt ratio as additional factors to the basic model. The coefficient of determinant of non-designated group has increased from t- 5(65.46%) to t-1(74.01%). The result is the same as the basic model, and the coefficient of determinant is larger than the basic model. In all years, the regression coefficients of EPS, BV, size, and debt are positive and that of Debt 2 is negative, and all the coefficients were significant at α=0.05 in all years. This means that size and debt ratio have significant additional effect on the stock price over EPS and BV, and the debt ratio affects the price in reversed U-shape. Also, the value relevance of accounting information has increased along the time passes. The coefficients of determinant of designated group have increased along the time passes. In year t-5, the coefficient of determinant was 56.12% which was slightly less than that of the non-designated group. The coefficient of determinant in t-4 (69.20%) was almost same as the no-designated group (68.36%), and after that period, the coefficients of designated group were higher than the non-designated group. The regression coefficients of EPS were insignificant from t-4 to t-1, and those of BV were significant except in the year t-1. The size effects the price during all periods similar to the non-designated group. However, contrary to the non-designated group, debt ratio has no effect on the price during all years. When the designated group was analyzed according to the causes of designation, the results were different between the two sub-groups. In the case of financial causes, the coefficients of determinant have increasing tendency from t-5 to t-2, and decreased in t-1. However, the coefficients of determinant were smaller in the non-designated group except in t-3 and t-2, and the coefficients of EPS were insignificant in all years. The coefficients of BV were significant from t-3 to t-1. These results showed that in the cases of the designation due to the financial causes, the earnings had effect on the stock price during all years, and book value had no effect on the stock price in t-5 and t-4. Debt ratio also had no effect on the stock price during all the periods. However, the size had effect on the stock price during all years. These results showed that the size was the important factors in the stock valuation, and the BV was restrictive factor in the case of the designation due to the financial causes. In the case of non-financial causes, the coefficients of determinant have increasing tendency from t-5 to t-2, and decreased in t-1. The coefficients of determinant were larger than the non-designated group except t-5, and were larger than the financial causes group during all years. The coefficients of EPS were significant in t-5 and t-1, and the coefficients of BV were significant in all years except t-4. The size also was significant in all years. However, the debt ratio was insignificant during all years. The results were different from the non-designated group and similar to designation due to the financial causes except EPS. 10

11 Therefore, in the case of non-financial causes, the value relevance of accounting information in extended model was different from non-designated group and slightly different from financial causes. According to the analyses of extended model, the value relevance of accounting information is different between the non-designated companies and the designated companies. Especially, EPS and debt ratio were clearly different between two groups, and the value relevance of accounting information between the causes of designation also varied except in the size variable. Non-Designation Designation All Financial Causes Non Financial Causes Table 5: The value relevance of extended model Time t-5 t-4 t-3 t-2 t-1 EPS BV Size Debt Debt R 2 (%) EPS BV Size Debt Debt R 2 (%) EPS BV Size Debt Debt R 2 (%) EPS BV Size Debt Debt R 2 (%) The cells are graded if the White heteroskedastictity constant coefficients are significant at α=0.05 The cells of R 2 (%) are graded if the F-value of regression is significant at α=

12 5. Conclusions and Recommendations This study examined the value relevance of accounting information for the companies designated as Issues for Administration in the KOSPI market of South Korea. First, the value relevance of accounting information was compared between the designated companies and non-designated companies from five year prior to designation. Second, the value relevance of accounting information was compared between the financial causes of designation and the non-financial causes of designation. The value relevance of accounting information was analyzed by the basic Ohlson model and extended Ohlson model which includes in debts ratio and size variables in addition to the basic Ohlson model. For the non-designated companies, the accounting information (EPS, BV, Size, and Debt ratio) has significant effect on the stock price during all years, and the debt ratio effected on the stock price as reverse U-shape. However, for the designated companies, the basic model was insignificant in t-5 and t-4 year, and the accounting information had restricted effect on the stock price except the size. Therefore, the value relevance of accounting information between the designated companies and non-designated companies was different. When the value relevance of accounting information was analyzed depending on the causes of designation, the value relevance of accounting information was slightly different between the financial causes group and non-financial causes group. The debt ratio had no effect on the stock price in both groups, and the size had significant effect on both groups. However, the effects of the EPS and the BV differed between the financial causes group and the non-financial causes group. Considering these results, the value relevance of accounting information was different in the designated companies and the non-designated companies, and that of accounting information also differed depending on the cause of designation. This research may contain selection bias because the relevance was compared between the designated companies and non-designated companies during 5 years prior to the designation. However, the financial characteristics of designated companies are different from that of the non-designated companies form the prior years of designation. Therefore, for the more elaborated analyses, it is needed to match the designated with non-designated companies by same financial characteristics in t-5. The propensity score match between the designated and non-designated companies in t-5 may be the one suggestable method. References Aboody, D., M. Barth, and R. Kasznik, 1999, Revaluations of Fixed Assets and Future Firm Performance. Journal of Accounting and Economics 26, Banz, R., 1981, The Relationship between Return and Market Value of Common Stock. Journal of Financial Economics, Barth, M., W. Beaver, and W. Landsman, 1998, Relative Valuation Roles of Equity Book Value and Net Income as a Function of Financial Health. Journal of Accounting and Economics 25,

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