Stock Return Effects of Accounting Information and Institutional Quality

Abstract

This thesis analyses the extent to which accounting information quality (AIQ) and institutional quality (IQ) influence stock return. It employs a sample of 39,490 listed firms across 45 countries from 1995 to 2013 using both macro and micro-level data and is estimated using System Generalised Method of Moments (System GMM). The thesis provides the following empirical evidence: that a firm’s earnings are persistent albeit cash flows show a higher persistence. Second, the thesis supports previous studies that establish that conservative accounting results in reversal of losses in future periods. Third, the thesis provides evidence that IQ positively affects AIQ where earnings management is employed as a proxy for AIQ. Moreover, while the study found no significant association between AIQ and stock return, a sensitivity analysis showed that the interaction of AIQ and IQ significantly affects stock return. The thesis makes the following contributions to literature: the use of System GMM thoroughly mitigates the endogeneity bias relating to firms’ stock return. Furthermore, the sensitivity effect of AIQ and IQ on stock return is also new in literature. Additionally, the thesis provides insight on how AIQ and IQ across different regions affect the stock return of firms operating in those regions. The thesis serves as evidence of the need for policies that directly address firm reporting behaviour and highlights the need for investors to supplement internally prepared financial information with more objective sources. Furthermore, the study shows how a country’s institutional environment contributes to its risk profile emphasises the need for investors to diversify across countries and not just across industries.