DO IFRS ADOPTION, FINANCIAL ANALYSTS AND EARNINGS QUALITY AFFECT THE INFORMATIVENESS OF STOCK PRICE? EVIDENCE FROM THE UK BY MOHAMMAD ALMAHARMEH Bachelor of Accounting (University of Jordan) M.Sc. in Accounting (University of Jordan) A thesis Submitted to the University of Salford, UK For the Degree of Doctor of Philosophy Salford University Business School 2017 I Abstract This thesis consists of two studies. The first study examines whether the mandatory adoption of International Financial Reporting Standards (IFRS) affects stock price informativeness, as measured by the extent to which firm-specific information is capitalized into the stock price. Using a sample of 6,367 firm-year observations from 970 publicly listed UK firms during the period from 1990 to 2013, the results show that the mandatory adoption of IFRS does make the stock price more informative. In particular, the results suggest a significant negative relationship between IFRS adoption and the stock price synchronicity. This indicates that the increased transparency following the mandatory adoption of IFRS facilitates the incorporation of firm- specific information into the stock price, leading to more informative stock prices. In this study, the effect of financial analysts’ activities on the relationship between IFRS adoption and stock price informativeness is also considered. The regressions results show that, within the IFRS adopters, the firms followed by a higher number of financial analysts have a higher stock price synchronicity than those followed by a lower number of financial analysts, suggesting that the IFRS adoption increases financial analysts’ ability to incorporate market-wide and industry-wide information into the stock price. Furthermore, these results indicate that the financial analysts’ activities attenuate the synchronicity-reducing effect of mandatory IFRS adoption. The second study, examines the effect of earnings quality on the informativeness of the stock price, using a sample of 5,214 firm-year observations, collected from 880 UK firms for the period from 1994 to 2013. The findings suggest that higher earnings quality encourages the investors to collect and process more firm-specific information, which in turn facilitates the incorporation of this information into the stock price, leading to less synchronous and more informative stock price. In addition, the effect of mandatory IFRS adoption on the relationship between earnings quality and stock price informativeness is examined. Contrary to expectations, the results suggest that the mandatory adoption of IFRS does not have a significant impact on the relationship between earnings quality and stock price informativeness. II ( َ لِيلًا ِ ليَّ ْي لع ْي ع ِ نع ْي ْع ِت ِيُمْت وْا ما ) مي ظع لا الله قدص Declaration I hereby declare that the materials contained in this thesis have not been previously submitted for a degree at this or any other university. I further declare that this thesis is solely based on my own research. Mohammad Almaharmeh Statement of Copyright The copyright of this thesis rests with the author. No quotation from it may be published without prior written consent, and information derived from it should be acknowledged. Mohammad Almaharmeh III Dedication This thesis is dedicated to the greatest two persons in this word, my father Issa Almaharmeh, and my mother Maysoon Almaharmeh. IV Acknowledgments I am grateful to God Almighty for giving me the opportunity, ability, courage and strength to complete this thesis. I would like to express my sincere thanks to a number of individuals who have provided me with support and encouragement throughout the period of my studies. I would first like to pay tribute, and thanks to my supervisors Dr. Eileen Roddy and Dr. Jia Liu to whom I owe a massive debt of gratitude for their priceless guidance and support in helping me during my PhD journey. They constantly encouraged me to expand the confines of my thinking and helped me to further explore and discover my abilities as a researcher. I am also thankful to my dad and my mother for their prayer, support and, courage throughout my life. With deep love, I am thankful to my wife, Ala, my sons, Hashem and Yamen, and my daughter, Sarah, for their unending support, unconditional love and understanding over the shortened weekends, truncated evenings and busy hours. Last but not least, I am grateful to my father in law, Prof. Mahmoud Abu-Zaid, for his support and invaluable help. V Table of Contents Chapter one: Introduction ............................................................................................................... 1 1.1 Introduction ...................................................................................................................... 1 1.2 Research Aims and Objectives .............................................................................................. 4 1.3 Research Questions ............................................................................................................... 4 1.4 Research Methodology .......................................................................................................... 5 1.5 Rationale for the Research and Expected Contribution to knowledge .................................. 6 1.6 Structure of the Study ............................................................................................................ 9 Chapter two: Literature Review .................................................................................................... 11 2.1 Introduction .................................................................................................................... 11 2.2 Stock price informativeness ........................................................................................... 12 2.2.1 The conceptual argument of using stock price synchronicity as a measure of stock price informativeness ............................................................................................................. 12 2.2.2 Empirical links between stock price non-synchronicity and stock price informativeness. ..................................................................................................................... 15 2.2.3 Stock price synchronicity as an indication of an uninformed trading .................... 27 2.3 Accounting transparency ................................................................................................ 28 2.3.1 Introduction .................................................................................................................. 28 2.3.2 The importance of accounting transparency ........................................................... 29 2.3.3 The history of International Financial Reporting Standards (IFRS) and its objectives ............................................................................................................................... 33 2.3.4 The UK accounting regulatory system ................................................................... 36 2.3.5 Anticipated benefits of IFRS adoption ................................................................... 36 2.3.6 Empirical evidence of the consequences of IFRS adoption ......................................... 37 2.3.6 Summary .......................................................................................................................... 50 Summary of stock price synchronicity literature ................................................................... 50 VI Summary of IFRS literature .................................................................................................. 52 2.4 Earnings Quality ............................................................................................................. 54 2.4.1 The definition of Earnings Quality ............................................................................... 54 2.4.2 Different measures of earning quality .......................................................................... 57 2.4.3 Accruals Quality as a universal measure of earnings quality ....................................... 58 2.4.4 Earnings quality and stock price informativeness ........................................................ 62 Chapter three: Theoretical framework and hypotheses development ........................................... 70 3.1 Introduction ......................................................................................................................... 70 3.2 The Effect of Accounting Transparency on Stock Price Informativeness. ......................... 70 3.2.1 Does Accounting Transparency Affect Stock Price Informativeness? ........................ 70 3.2.2 Do financial analysts’ activities matter? ....................................................................... 73 3.3 The Effect of Earnings Quality on Stock Price Informativeness ........................................ 75 3.3.1 Does Earnings Quality Affect Stock Price Informativeness ........................................ 75 3.3.2 Does IFRS Adoption Matter? ....................................................................................... 80 Chapter Four: Research Methodology .......................................................................................... 82 4.1 Introduction ......................................................................................................................... 82 4.2 Research philosophy ........................................................................................................... 82 4.3 Research approach............................................................................................................... 86 4.4 Research strategy................................................................................................................. 87 4.5 Sample selection and data sources. ..................................................................................... 88 4.5.1 Sample selection ........................................................................................................... 88 4.5.2 Data type and source ..................................................................................................... 90 4.6 Methods of analysis and investigation. ............................................................................... 91 4.6.1 Univariate analysis ....................................................................................................... 91 4.6.2 Bivariate analysis .......................................................................................................... 91 VII 4.6.4 Multivariate analysis..................................................................................................... 92 4.7 Variables measurement ....................................................................................................... 99 4.7.1 Dependent variable (Stock price informativeness measure) ........................................ 99 4.7.2 Independent variables ................................................................................................. 101 4.7.3 Control Variables ........................................................................................................ 107 4.8 Empirical models for hypothesis testing ........................................................................... 112 4.8.1 First Study Empirical Models ..................................................................................... 113 4.8.2 Second Study Empirical Models .................................................................................... 116 Chapter Five: First Study Empirical results (Accounting transparency and stock price informativeness.) ......................................................................................................................... 121 5.1 Descriptive Statistics ......................................................................................................... 121 5.1.1 Sample Description..................................................................................................... 121 5.1.2 IFRS Adoption ............................................................................................................ 123 5.1.3 Yearly summary of stock price synchronicity ............................................................ 124 5.1.4 Descriptive statistics and Univariate comparisons ..................................................... 128 5.1.5 Correlation Analysis ................................................................................................... 133 5.2 Bivariate analysis .............................................................................................................. 137 5.3 Multivariate analysis: IFRS adoption and stock price informativeness ............................ 142 5.3.1 The results of testing H1 ............................................................................................. 142 5.3.2 Robustness test for H1 using different measure of stock price synchronicity............ 147 5.3.3 The results of testing H2 ............................................................................................. 149 5.3.4 Robustness test for H2 using different measure of stock price synchronicity............ 155 5.3.5 The results of testing H3 ............................................................................................. 161 5.3.6 Robustness test for H3 using a different measure of stock price synchronicity ......... 163 5.3.7 Additional robustness tests with control of potential endogeneity ............................. 165 VIII 5.3.8 Additional robustness tests using Difference in Difference analysis ......................... 169 Chapter Six: Second study Empirical Results (Earnings quality and stock price informativeness) ..................................................................................................................................................... 173 6.1 Sample description ............................................................................................................ 173 6.2 Descriptive Statistics ......................................................................................................... 174 6.3 Correlation Analysis .......................................................................................................... 176 6.4 Bivariate Analysis ............................................................................................................. 181 6.5 Multivariate Analysis ........................................................................................................ 185 6.5.1 Do earnings quality affect stock price informativeness? ............................................ 185 6.5.2 Does IFRS adoption affect the relationship between earnings quality and stock price informativeness? .................................................................................................................. 190 6.6 Robustness tests................................................................................................................. 193 6.6.1 Robustness test using different measure of stock price synchronicity ....................... 193 6.4.2 Robustness tests using different measure of earnings quality .................................... 197 6.3.3 Endogeneity Issues ..................................................................................................... 200 Chapter 7: Conclusion................................................................................................................. 205 7.1 Introduction ....................................................................................................................... 205 7.2 Empirical results conclusions ............................................................................................ 205 7.2.1 Mandatory IFRS adoption and stock price synchronicity .......................................... 206 7.2.2 Earnings quality and stock price synchronicity .......................................................... 209 7.3 The contributions of the study .............................................................................................. 211 7.4 Implications of the study ....................................................................................................... 212 7.5 The limitations of the study and suggestions for future research ......................................... 212 References ................................................................................................................................... 215 IX Abbreviations IAS International Accounting Standards IFRS International financial reporting standards EU European union L.S.E London stock exchange UK The united kingdom USA United states of America IASC International Accounting Standards Committee IASB International Accounting Standards Board GAAP Generally Accepted Accounting Standards OLS Ordinary least square GLS Generalised least square WLS Weighted least square DW Durbin-Watson test 2SLS Two stage least square RET Weekly firm return MKERT Value-weighted market return INDRET Value-weighted industry return SYNCH1 Stock price synchronicity computed using EQ.1 SYNCH2 Stock price synchronicity computed using EQ.3 NIBEX Net income before extraordinary items X