Value relevance and predictive ability of financial statement information : the case of Saudi Arabia

The Saudi financial reporting environment witnessed significant development in the past two decades, which is evidenced by the incorporation of the Saudi accounting standard setter (Saudi Organization for Certified Public Accountants (SOCPA)) and its subsequent development of the accounting profession. The main objective of this study is to investigate whether developments in financial reporting following SOCPA’s inception resulted in financial statement information being more value relevant over time. This study focuses solely on quantitative methods and employs secondary data in addressing the research questions. This study uses adjusted R² as a primary metric for measuring value relevance. Value relevance of accounting information has been investigated through its association with contemporaneous market values and future cash flow-predictive ability studies. The theoretical frameworks of Ohlson (1995)and Easton and Harris (1991) have been used to specify the relationship between accounting information and market values. To link accrual-based earnings and accrual components with future cash flows, the theoretical frameworks of Dechow, Kothari and Watts (1998) and Barth, Cram and Nelson (2001) have been used. A sample of firms listed in the Saudi Stock Market during the 1993–2009 time period has been used. The total number of observations included in the sample is 997 from 97 firms, which excludes firms in the banking and insurance sectors. The main findings of the value relevance of accounting information in equity valuation are: First, earning (book value) coefficients were found to be significant in (nine) all years in the price regressions. Second, earning levels and changes have not been found significantly related to stock returns in all years. Third, hedge portfolio strategies based on pre-knowledge of accounting information yielded non-zero returns. Fourth, the explanatory power of the price model increased from the 1993–1997 to the 1998–2003 time period and declined in the following time period. Fifth, the explanatory power of the return model shows no significant change over time. Sixth, earnings are not value-relevant in equity valuation for loss-making firms, while book value is value-relevant for the 1993–1997 and 1998–2004 time periods. Earnings are only asymmetrically timely in reflecting good and bad news in the 1998–2003 and 2004–2009 time periods. Findings from the predictive ability of future cash flows show that earnings provide incremental explanatory power beyond that provided by current cash flows in all three pooled cross sections. Earnings’ accrual components have also been found been found to significantly provide incremental explanatory power beyond that provided by current cash flows in predicting future cash flows. These two measures did not witness any significant change over time. Earnings as a summary measure have not been found to outperform current cash flows in their predictive ability except for three years. This study concludes that accounting information has been value relevant during the entire period of this study and that an increase in value relevance might only be present in the early period of this sample.