The Empirical Study On The Information Content Of Prices

The relation between security prices and accounting earnings is one of the most explored areas of accounting research. The relation was initially characterized as percentage changes in price expressed as a linear function of percentage change in earnings. Beaver, Lambert and Ryan (1987) focused on the information content of prices, and made the relation more explicit by introducing the "reverse" regression that reversed the dependent and independent variable. They argued that prices can reflect the information about future earnings, that is, prices have information content.As we have known, earnings have information content of prices, and if prices also have information content of future earnings, then the relation between prices and earnings will be bivariate. The relation of prices and earnings can be reversed. And there will be a bias in prices—earnings regressed function, and this bias asks for us to find another method to estimate the coefficient. A simultaneous equations approach is a good choice.The information content of prices was a focus of abroad empirical research in the 1980's, but the research of the information content of prices is still a virgin field in domestic research. All the study in our country characterized the relationship between security prices with earnings as the dependent variable. Despite the variety of specifications, one common feature shared by these studies is the adoption of a single-equation estimation approach. But there is a reversed relation between price and earnings. As a result, the traditional single equation approaches potentially suffer from under identification and bias. So realizing the relation between prices and earnings is reversed is very important for our empirical study.This article analyze why prices can convey the information of future earnings. One of the two reasons is that accounting earnings have limited ability to contemporaneously reflect the market's revised expectations offuture cash flows. Such limited ability is attributable to the conservatism, objectivity, verifiability, and other conventions that underlie Generally Accepted Accounting Principles (GAAP). Prices' predictive ability is richer than that in the past time series of earnings is the other reason. Price change over a period reflects revision in the market's expectation of future earnings as well as realized earnings over the period.Based on the analysis of theory above, we build the reversed regression that views the percentage of earning changes as the dependent variable, and the percentage of price's changes as the independent variable. And we use the data from Shanghai stock market to test whether prices can reflect the information of future earnings. And we get a confirmative answer. We also find the ability of prices to reflect future earnings are weaker and weaker with time passes.We have get confirmative answers about prices have information content of future earnings and we want to study whether there is a difference between the ability of prices to reflect future profit and ability to reflect future loss. We put our data into two groups; one has positive earnings and the other have negative earnings. Using the reversed regression, we get two prices coefficients, and we can see that the two coefficients have obviously differences. The coefficient of the profit group is larger than that of the loss group. This result is consistent with our assumption. We attribute the reason to two points: one is the earning manipulation the other is market participants are over worried for the negative information of a company. From the analysis above, we can see that both earnings and prices have information content of each other. The relation between earnings and prices are bivariate. Empirical tests for endogeneity indicate that price changes and earnings changes act as if they are endogenously determined. A system of simultaneous equations is introduced to mitigate bias. Consistent with our predictions, the earning reflection coefficient obtained from this approach are larger than those obtained from single-equation approaches.