Studying the effect of increase of capital on the traditional and modern financial criteria in the companies listed in Tehran Stock Exchange

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1 Available online at Scinzer Journal of Accounting and Management, Vol 2, Issue 4, (2016): DOI: /SJAM ISSN Studying the effect of increase of capital on the traditional and modern financial criteria in the companies listed in Tehran Stock Exchange David Rostami, Mahdi Yaghoubi, PhD; Mohammad Reza Karimi Pouya, PhD, Department of Accounting, Hamedan Branch, Islamic Azad university, Hamedan, Iran Abstract: When it comes to increase of the company's capital, owners, managers, investors, government, banks, and creditors, before taking any action and movement want to know that after the capital increase, how the company status will be, and it is here that the evaluation criteria for the evaluation of principles and specific conditions are considered. In this regard, the purpose of the study is to investigate the relationship between capital increase and traditional and modern performance evaluation criteria (return on assets (ROA), Market Value Added (MVA), and Economic Value Added (EVA). The population of the study is all companies listed on the Tehran Stock Exchange, which is 123 companies through systematic elimination, in the period of 2005 until To study the correlation of capital increase with ROA, MVA, EVA, statistical tests of Friedman and covariance are used, respectively, for research data before and after normalizing the data in Spss and Eviews software. The results of testing the hypotheses indicate that capital increase, in the population studied, has no significant relationship with ROA as the first hypothesis, but it has correlation with EVA and MVA as the second and third hypotheses. Keywords: capital increase, performance evaluation criteria, ROA, MVA, EVA Introduction Stock market, as any other market, has principles and specific conditions by considering and applying which, one take action in investment, management, sales, accreditation procedures, and reaching a real understanding of the issues on the stock exchange. In terms of capital market participants, announcement of holding of the extraordinary general meeting to approve the capital increase as financial news can affect the stock price and thus its efficiency "(Ebadi and Hassanpour, 2011, 45-46). Publishing stocks has the advantage of not having a maturity date and the firm is not subject to refund funds and commits only to the payment of dividends (if any), but causes dividing ownership of the firm between a large number of people. All groups involved in the stock market should make extensive investigations before any action, and if they attempt to move regardless of a series of factors, they will not get favorable results from their labor, capital, and time. In this regard, the purpose of the study is to investigate the relationship between capital increase and traditional and modern performance evaluation criteria (ROA, MVA, and EVA). An overview of the stock prices of companies that have published common stock shows that usually shareholders after the date of announcement of the capital increase earn abnormal returns. In other words, capital increase increases shareholder wealth, and this increase is not necessarily due to positive changes in profit, but the result of speculation, misconceptions, and lack of awareness of investors of the information contents of capital increase. Increase in stock price and market value of the firm due to capital increase will have stability and continuity only when the company's earnings and returns are proportionally balanced. Otherwise, due to the cost of financing through capital increase, company's stock price declines, reducing the company's market value (Wadii and Razavi Rad, 2008, 173). Statement of the problem Publishing stocks can indicate that the company has profitable projects for growth and development at hand. As a result, it can bring about market sensitivity and changes in the stock returns (Rahnmay Roodposhti et al., 2010, 68)." An overview of the stock prices of companies that have published common stock shows that usually shareholders after the date of announcement of the capital increase earn abnormal returns. In other words, capital increase increases shareholder wealth, and this increase is not necessarily due to positive changes in profit, but the result of speculation, misconceptions, and lack of awareness of investors of the information contents of capital increase. Increase in stock price and market value of the firm due to capital increase will have stability and continuity only when the company's earnings and returns are proportionally balanced. Otherwise, due to the cost of financing through capital increase, company's stock price declines, reducing the company's market value (Wadii and Razavi Rad, 2008, 173). Therefore, any decisions made in this section by business unit managers have severe effects on an entity's efficiency that ultimately leads to change in the corporate value and shareholders' wealth.

2 Thus, by reviewing and analyzing the effects and the probable relationship between investment growth policies and performance based on economic criteria, we can understand the importance of financial behavior of the firm towards the sources and investment uses of capital, and increase the possibility of wealth production for shareholders in the light of this understanding. Therefore, from this perspective, the aim of this study will be to answer the following question. What relationship does capital increase have with traditional and modern criteria to evaluate the performance (ROA, MVA, and EVA) in the companies listed in the Tehran Stock Exchange? The importance of the research Groups such as owners, managers, investors, governments, banks and creditors pay special attention to the issue of evaluating corporate performance and consider it important and significant. Moreover, in this regard, different criteria are created for evaluating the performance, each of which measure is appropriate in its own scale. The required information for these criteria is obtained from the financial statements, economics, free market, or a combination of them can be achieved, and each one has its own pros and cons. The issue of studying the effects of capital increase on performance evaluation criteria has widely been studied in countries in recent years. The overall results of this research and in various stock exchanges including the US, Greece, India and China reflect that there is a remarkable significant relationship between the company's capital increase and financial and economic criteria of measuring performance. Given the above, and considering that so far, no research in Iran has tackled, directly and comprehensively, studying the relationship between the increase in capital, performance measure criteria in companies listed on the Tehran Stock Exchange, so the necessity, and importance of conducting such research is greatly felt. Although domestic research in relation to the increase in capital abound, the effect of the capital increase on ROA, EVA, and MVA has not extensively been studied. The only ones somewhat related to the topic of this research are: In the study by Ahmadi (Shahid Beheshti University, 2006), it is tried to determine the different dimensions of capital increase and the factors influencing various aspects of the the opening price of the shares after the capital increase and the presence or absence of correlation between price elasticity of demand for the share and share price changes. Mirzaee (Shahid Beheshti University, 2005) studied the effects of capital increase methods on the price and trading volume of the stock, and examined the presence or absence of a significant difference between more than two sample means. The results of previous studies have been consistent and are contradictory. This survey tries to offer a framework of the effects of capital increase on traditional and modern performance evaluation criteria, based on which, one can obtain the following objectives: 1) ensuring the efficient allocation of limited resources that shareholders and creditors offer to the firms, 2) a basis for management control system, 3) a basis for reasonable management decisions, and 4) a basis for rewarding managers. Research background Stewart (1991) ranked 613 firms of top 1000 American companies in terms of average EVAduring 1987 and 1988 and divided them into 25 groups. The study was based on the average EVA and MVA for each of the 25 groups and based on their changes. The result showed that in companies with positive EVA, there is high correlation between these two measures, their means, and their changes (Coefficient of determination 97%), while in companies with negative EVA, the correlation of these two criteria was not very significant. "Finnegan" expanded the analysis discussed above to consider other indicators. The regression results of MVA against EVA and other criteria indicated that EVA compared to other measures studied has more power, coefficient of determination (61%). He also analyzed the change in MVA and again found that EVA is above all other criteria. The coefficient of determination of this criterion was 44%, while the coefficient of determination of capital was 35%. Obiron used ten-year information (from 1985 till 1994) of companies listed in 1000 performance to test explaining the power of capital EVA (EVA divided by the cost of capital), net operating profit after tax (NOPAT) and free cash flow (FCF) in relation to the market value divided by invested capital (IC). His findings showed that EVA explains almost 31% of the variance of market value, while the coefficient of determination of operating profit after reducing tax is only 17 percent. Obiron concluded that EVA, unlike NOPAT or other profit criteria, is legally basis linked to the market value. Pablo Fernandez analyzed 582 American companies using data of MVA, EVA, NOPAT and WACC (weighted average cost of capital) provided by Stern Stewart. For each company, the correlation of ten years between the growth of MVA and NOPAT, EVA and annual WACC was calculated. In the end, he concluded that one cannot introduce EVA as the best performance index and a representative of MVA, but in this case, NOPAT gives better results (Nakhaei.2016). In a study entitled as studying the methods of financing in the value of listed companies in Tehran Stock Exchange, Ahmadi Mansourian (2015) concluded that companies that have used capital increase have not had a positive impact on real stock returns, but companies that have used loans have had a positive effect on real stock returns. 39

3 In a study entitled as explaining the relationship between performance measurement criteria and performance rating growth of the companies, Afshar and Zamani Amougin (2014) concluded that there is a positive and significant relationship between the overall rank of the company in performance evaluation indicators and growth of companies. In a study entitled studying the relationship between EVA information content and traditional criteria with MVA, Assadi et al. (2013) concluded that the information content of EVA has no priority in return on equity, NOPAT, and earnings per share in explaining the changes in MVA. However, simultaneous entry of EVA alongside traditional measures increases the explanatory power of MVA. In other words, EVA has increasing information content. In a study as MVA and the traditional accounting standards, the best indicator of stock returns in Malaysian companies, Nakhaei (2016) concluded that there is no significant advantage in MVA compared to traditional accounting criteria for predicting stock returns, and that EVA alongside other traditional criteria can better predict stock returns of companies in Malaysia stock market. In a study entitled as investigating the relationship between MVA and standardized EVA and accounting performance measures in firms listed in the Tehran Stock Exchange, Pour Ali and Roze (2013) concluded that there is a significant relationship between MVA, EVA, and ROA. In one study entitled as value creation for shareholders, evidence of Malaysian companies, Yahya and Mahmoud (2011) concluded that most Malaysian companies do not have the power to cover the cost of capital increase and this issue has caused their EVA and MVA to be at low level. In a study entitled as the performance of Malaysian companies after the economic crisis of 1997, using EVA, Ismail (2011) concluded that EVA has a significant relationship with stock returns compared to the traditional criteria for performance evaluation. Research hypotheses A hypothesis is a scientific and subtle speculation, which is predicted for the outcome of the investigation, and is measured compared to the scientific results against the benchmark. In any scientific research, the researcher usually considers one or more hypotheses in his study to conduct his research in a specific order. This study has three hypotheses as follows: 1. There is a significant relationship between capital increase and ROA. 2. There is a significant relationship between capital increase and EVA. 3. There is a significant relationship between capital increase and MAV. Variables and measuring them The relation used in calculating the rate of ROA In this study, ROA is obtained from the following equation: PA non current assets References: Piri et al. (2013), Mahdavi (2012), Ebadi and Hassanpour (2011) The relation used in calculating MVA MVA = (stock price) (number of shares)-equity References: Hejazi and Hussaini (2010), Wadii and Razavi Fard (2008) The relation used in calculating EVA In this study, the method of calculating EVA is by using the following relationship: ( ) After replacing it in the relation: ( ) Whose components are: r=roa, c= the cost of capital, Nopat = net operating profit after tax Capital = Capital used Return on capital in the above calculations is calculated using the above equation: 40

4 It calculates utilization rates of the capital used, regardless of the method of financing and free of accounting distortions, which result from accrual of records of conservatism and not considering unsuccessful attempts to invest. Capital is obtained from accumulation of Net Working Capital and net fixed assets, and net working capital by subtracting current liabilities from Non-Interest-Bearing Current Liability (NIBCLs). Moreover, net fixed assets include Property, Plant, Equipment and other long-term assets that are necessary for continuation of companies operations. References: Khodaparast (2010), Heidarpour and Nayeb (2009), Hejazi and Hussaini (2010), Talebnia and Shojaa (2011) Population The study population included all the companies listed on the Tehran Stock Exchange. It is worth mentioning that selecting the companies listed on the Tehran Stock Exchange as the population is because almost the most usable information about Iranian companies is in this institution, and they are the only companies whose stocks is priced and traded on the stock market. To determine the population, with exercising the following restrictions, systematic deletion sampling has been used. Table 1: Details of selecting the population Explanations Frequen cy The total number of licenses for the increase of the capital issued by Tehran Stock Exchange in the period 504 from March 2005 until March 2014 The total number of companies with license to increase capital in the period from March 2005 until March The total number of licenses issued to increase capital for companies active in the financial industry, (49) investment, and banks and holdings In order to homogeneity, companies whose end of fiscal year is not March 20 (24) Firms lacking audited financial statements and license for capital increase in the time domain (23) The total number of companies that have capital increase licence during three consecutive years (14) The number of companies eliminated during the study due to lack of information and documents required (3) The remaining companies 123 Methods and tools for data collection In this study, theoretical concepts are collected through library method by referring to Persian and English books and journals and data required are collected by referring to the financial statements, notes, weekly and monthly reports, and monthly of Stock Exchange. In other words, data collection and data in this study can divided into two stages. In the first stage, for compiling literature, library method and note taking are used, and in the second stage, Excel software is used for data from companies, members of the population. The analysis of the first hypothesis Hypothesis: There is a significant relationship between capital increase and ROA. Table 2: Ranking the average data of ROA before and after the capital increase with Friedman test Rank in repeated measurements in terms of average 1.04 ROA before capital increase (ROA1) 2.96 ROA in the year of capital increase (ROA2) 2.00 ROA one year after capital increase (ROA3) Based on the results set forth in Table 2, it can be said that ROA in the year of increase of capital has a higher rank compared to the year before and after the capital increase (2.96). In other words, ROA in the year of declaration in raising capital in the financial statements of companies has increased. Table 3: The result of analysis of covariance, studying the first hypothesis of research in Eviews software Correlation t statistic p-value coefficient The relationship between capital increase and ROA in the year of

5 capital increase (ROA2) The relationship between capital increase and ROA in the year after capital increase (ROA3) According to Table 3, the output of the covariance test in the correlation between the increase in capital and ROA (first hypothesis), it can be said that as the p-value observed (0.043) is less than significant level 0.05, so with 0.95 level of confidence, it is concluded that the capital increase has 18% positive correlation with ROA in the year of capital increase. Moreover, statistic t (2.045) is larger than critical limit 1.96 and confirms this issue. 1 However, the correlation between the increase in capital and ROA in the year following the capital increase is not confirmed at 95 percent level of confidence, because p-value and t-statistic are and 1.767, respectively, and smaller than necessary values 0.05 and The analysis of the second hypothesis Hypothesis: There is a significant relationship between increasing capital and EVA. Table 4: Ranking the average data of EVA before and after the capital increase with Friedman test Rank in repeated measurements in terms of average 2.00 EVA before the capital increase (EVA1) 1.44 EVA in the year of the capital increase (EVA2) 2.56 EVA in the year after the capital increase (EVA3) Based on the results set forth in Table 4, it can be said that EVA in the year after the capital increase has a higher rank compared to the previous year and the capital increase year (2.56 against 2.00 and 1.44). In other words, EVA of the companies surveyed overall reduces in the year of announced capital increase, but increases in the the following year, compared to the year before the capital increase. Table 5: The result of analysis of covariance, studying the second hypothesis of research in Eviews software Correlati t statistic p-value on coefficient The relationship between capital increase and EVA in the year of capital increase (EVA2) The relationship between capital increase and EVA in the year after capital increase (EVA3) According to Table 5 of the output of covariance in the correlation between the increase of capital and EVA (second hypothesis), it can be said that as the p-value observed in both rows (0.000 and 0.000) is smaller than the significance level 0.05, with 95% confidence, it can be concluded that capital increase has a positive correlation with EVA in the year of capital increase at 66% level and also in the year following it. Moreover, t statistics (8.621 and 8.658) confirm this due to being larger than critical value Thus, with 95% level of confidence, the second hypothesis stating the relationship between capital increase and EVA in the population studied is confirmed. The analysis of the third hypothesis Hypothesis: There is a significant relationship between capital increase and MVA. Table 6: Ranking the average data of MVA before and after the capital increase with Friedman test Rank in repeated measurements in terms of average 2.00 MVA before the capital increase (MVA1) 1.00 MVA in the year of the capital increase (MVA2) 3.00 MVA in the year after the capital increase (MVA3) Based on the results set forth in Table 6, it can be said that MVA in the year after the capital increase has a higher rank compared to the previous year and the capital increase year (3.00 against 2.00 and 1.00). In other words, MVA of the 1 Thus, if the value of t-statistic is greater than the absolute value of 1.96, at 95% level of confidence, the relation is verifiable. 42

6 companies surveyed overall reduces in the year of announced capital increase, but increases in the the following year, compared to the year before the capital increase. Table 7: The result of analysis of covariance, studying the third hypothesis of research in Eviews software Correlation t statistic p-value coefficient The relationship between capital increase and MVA in the year of capital increase (MVA2) The relationship between capital increase and MVA in the year after capital increase (MVA3) According to Table 7 of the output of covariance in the correlation between the increase of capital and MVA (third hypothesis), it can be said that as the p-value observed in both rows (0.000 and 0.000) is smaller than the significance level 0.05, with 95% confidence, it can be concluded that capital increase has a positive correlation with MVA in the year of capital increase at 57% level and also in the year following it. Moreover, t statistics (7.714 and 7.689) confirm this due to being larger than critical value Thus, with 95% level of confidence, the third hypothesis stating the relationship between capital increase and MVA in the population studied is confirmed. Practical suggestions According to the result of the first hypothesis, it is suggested that decisions on investing and welcoming capital increase of the companies listed on Stock Exchange not be taken just based on high or low ROA, because as was observed in the survey population, the significant correlation between the increase in capital and ROA was not confirmed. According to the second hypothesis, it is suggested that welcoming the increase in capital and investment be done for the companies with higher EVA than other ones, because based on the result of this hypothesis, there is a significant correlation between the increase in capital and EVA. According to the third hypothesis, it is suggested that, like the suggestion related to the second hypothesis, investors show a particular preference in welcoming and investment in firms that have higher MVA compared to other companies. References Afshar, M. Zamani Amougin, (2014). Explaining the relationship between performance measurement and performance rating with growth companies, Shiraz University of accounting developments, Volume 6, (1) Ahmadi Mansouri, M (2015). Methods of financing on the value of companies listed on the Tehran Stock Exchange. Master thesis, Islamic Azad University, Science and Research Assadi, A.R, Zendeh Del, A. Kianinejad, A (2013) Relationship information content of EVA and traditional measures of value-added market companies, Review of accounting and auditing, Tehran University of Management, Volume 20 Number 2 Page 1-18 Ebadi, J. Hassanpour, I (2011). The capital increase and its impact on abnormal returns based on the evidence of Tehran Stock Exchange Securities Journal fiscal analysis. No 10 Foreign references Ismail, I. (2011). "Company Performance in Malaysia after the 1997 Economic Crisis: Using EVA(EVA) as a Predictor". African Journal of Business Management, 5(7), Khodaparast, A (2010). The relationship between economic value and return on investment. Monthly issues and economic policies. 11 and Mahdavi, G.H, Ghorbani, A (2012). Comparative study of the role of modern and traditional liquidity indicators in assessing the financial performance of companies listed on the Tehran Stock Exchange. Journal of Financial Accounting, Year 4 (1), Nakhaei,Habibollah.(2016). MVAand traditional accounting criteria: Which measure is a best predictor of stock return in Malaysian companies. Iranian Journal of Management Studies (IJMS). pp Piri, P. Heidari, H. Raouf, S. (2013). 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