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an investigation of the usefulness of accounting information for ...

an investigation of the usefulness of accounting information for ...

To overcome

To overcome these anomalies, Lev & Thiagarajan (1993) introduced 12 financial signals claimed by analysts to be useful in security valuation and that reflect traditional rules of fundamental analysis. These signals include information about changes in inventories, account receivables, capital and research and development expenditures, gross margins, selling and administrative expenses, provision for doubtful receivables, effective tax rates, order backlog, labour force productivity, inventory methods and audit qualifications. They show the value relevance of these fundamental signals with respect to their significant correlation in the direction predicted with contemporaneous returns after controlling for current earnings innovations, firm size and macroeconomic conditions. Non-financial information by financial analysts in their decision-making process has been the subject of prior studies. According to Amir and Lev (1996) defined nonfinancial information as non-accounting information. In addition, Barker and Imam (2008) stated that non-accounting information is all information drawn from outside the financial statements. According Graham et al. (2002) and Liang & Yao (2005), financial analysts examine the relevant non-financial information prior to judge the value of firms. According to Brown and Rozeff (1978), financial analysts are able to incorporate more timely firm and economy news into their forecasts. Non-financial disclosure has an impact on the quality of financial analysts’ earnings estimates. According to Vanstraelen et al. (2003), there is a positive association between financial analysts’ earnings forecast accuracy and forward-looking disclosures. Moreover, Barron et al. (1999) demonstrated that better quality information included in the Management and Discussion Analysis enhances the accuracy of the analysts’ earnings forecast. The relevance of non-financial information is also considered by Martinez (2007) who found that a substantial proportion of an analyst’s report includes non-financial information. Flostrand (2006) also showed that analysts reports issued for firms in the pharmaceutical industry and the telecommunications industry contain more intellectual capital information compared with analysts’ reports on energy firms. Bouwman et al. (1995) demonstrated that financial analysts collect non-financial information to gain a better insight into firm performance and to observe unusual facts. Dempsey et al. (1997) conducted a survey among financial analysts, finding that financial analysts often use non-financial performance measurements to assess firms. However, Opdyke’s (2000) observed that a strong focus by financial analysts on financial data does not yield accurate earnings forecast. But Orens and Lybaert (2007) argued that by using more forward-looking information, as well as information about innovation and research and development, small errors would occur in estimating future earnings. These results confirm the survey findings of Epstein and Palepu (1999) and Eccles et al. (2001) showing that financial statements are insufficient for meeting financial analysts’ information needs. 4

In literature, there is also evidence of analyst bias in forecasting and making recommendations Brown et al. (1985) indicated that analyst earnings forecast tended to be optimistic and that their recommendations were almost exclusively for buys. But this argument was counteracted by Matsumoto (2000) who pointed out that there has been a marked decline in analyst optimism. Moreover, Orens and Lybaert (2007) concluded that there is a negative association between the financial analysts’ use of non-financial information and the earnings informativeness of firm’s financial statement information. The results showed that less experienced financial analysts tend to make more use of non-financial information and covering a higher number of firms. However, Skinner (2008) pointed out that despite the increasing importance of nonfinancial information, such information is hard to mandate and to standardize due to the firm and industry-specific nature of non-financial information, the disclosure costs and the risk of receiving vague and uninformative disclosure. Voluntary non-financial disclosure is considered to be more effective in improving the efficient functioning of capital markets rather than mandating non-financial disclosure. Indeed, Gomes et al. (2007) stated that the increased information requirements are additionally detrimental for small listed firms as they lack financial resources to provide this information. In addition, Mavrinac (1995) found no support for regulatory requirement of non-financial information. Various initiatives have therefore recommended firms to disclose nonfinancial information voluntarily. The AICPA (1994) developed a business reporting model which includes non-financial information that firms could report voluntarily. The FASB (2001) extended this reporting model by the inclusion of intangible-related information. However, Buzby (1975) consisted of 39 items of financial and non-financial information appearing in annual reports, which was then presented to a selected user group of professional financial analysts. According to Firth (1978), a company should consider the needs of the end users when determining the disclosure policy to adopt. Beaver, Kelly and Voss (1968) pointed out an interesting argument that information is useful only to the extent to which it predicts future events. In addition, Pankoff and Virgil (1970) stated that the usefulness of information depends on the extent to which information facilitates decision making. But, Firer and Meth (1986) reported that there is little positive correlation between the investors’ information requirements and the disclosure of such information in annual reports. 5

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