Latin American Capital Markets

ACCOUNTING AND AUDITING STANDARDS 215formation and disclosure in current and past financial statements in conjunction withmacroeconomics and sector data to arrive at the firm's intrinsic value.The difference between the intrinsic value and the current market valuedrives the activity of the stock market, indicates the reward expected for investing inthe security, and ultimately drives the economic allocation of resources. However ifFama's (1970, 1991) statement that "security prices fully reflect all available information"is correct, the reward from fundamental analysis, and therefore from accounting,would be greatly reduced, possibly leading to the collapse of markets because therewould be little incentive to gather costly information, and trade and liquidity woulddisappear (Grossman and Stiglitz 1980).Therefore, the knowledge of an informationallyefficient capital market is enormously relevant for investors, regulators, and standardsetters. In an efficient market, theoretically, the choice between disclosure in thefootnotes and full disclosure in the financial statement does not have a relevant impacton the price of securities. Conversely, inefficient markets would require fundamentalanalysis and accounting standards.After many years of studies and research and thousands of articles and papers,financial economists have not settled the issue about whether financial marketsare efficient (for example, the efficient markets hypothesis). What has become relevant,however, is not the absolute concept of market efficiency, but rather the relativeconcept of efficiency. For example, a particular market might be efficient relative toother markets or to a certain type of information.In the context of relative efficiency, numerous studies have been undertakento analyze the link between accounting and capital markets. Ball and Brown (1968)study the impact of accounting numbers on capital markets; Ball and Kothari (1991)analyze the impact of earnings announcements on security prices; Ball (1972) looksat the impact of changes in accounting methods on security prices.The various studiesshow that capital markets are informationally inefficient and prices would takeyears before they would fully reflect all available information.The research has demonstratedthat historical cost reporting and financial statement numbers—includingquarterly earnings—reflect information that influences security prices although it isnot necessarily timely. This suggests that accounting, while relevant, does not constitutea monopoly source of information. This is confirmed by studies showing thatprices lead accounting earnings (Collins and others 1994). It also allows the conclusionthat, even in an ideal efficient market, fundamental analysis plays a crucial role inguiding knowledge about what drives value. The research demonstrates that fundamentalvaluation—a function that goes beyond accounting—relies heavily, but not ex-Copyright © by the Inter-American Development Bank. All rights reserved.For more information visit our website: www.iadb.org/pub