Stephen Penman

Accounting Changes and Stock Prices: An Examination of Selected Uncontrolled Variables

Coauthor(s): Ian Eggleton, John Twombly.

Abstract:

This paper is presented within the context of two streams of research which can be identified in the current literature of empirical accounting research. Both of these research areas deal with changes in accounting methods. The first deals with the motivation for changes in accounting methods, and the second area, attempts are made to discover the consequences of accounting changes in terms of the reaction of capital markets to the output of the accounting process. Appealing to the theory of capital market efficiency [Fama 1970] and to the framework of the two-parameter capital asset pricing model [Sharpe 1964; Lintner 1965], the researchers conclude that a change in accounting method per se has little effect on the market price unless accompanied by changes affecting the economic value of the firm.

These two streams of research have been pursued independently. One implied criticism of the motivation approach is that an investigation of the causes of accounting changes is excrescent, since these changes have little effect on market prices. However, the internal validity of the research on the association of accounting changes with stock prices can also be questioned, since the only variable usually considered is the accounting change.

If, in fact, the market is simultaneously reacting to other phenomena associated with the firm's production-investment decisions when the accounting change's market effect is observed, the observed reaction, including an anticipatory reaction, cannot be uniquely ascribed to the accounting change. It may be that the phenomena which have been interpreted as the causes (or correlates) of accounting changes produce effects on stock prices, with such reactions interpreted as relating to accounting changes. Alternatively, accounting changes may indicate the existence of these other factors. In short, the accounting change may be both evidence of and a product of another change of economic significance.

The objective of this paper is to provide some evidence on the relationship between intervening factors not controlled for in most existing research and changes in the method of accounting for inventory. In doing so, we hope to provide an illustrative answer to the "pragmatic" objection to the motivation research.

Source: Journal of Accounting Research
Exact Citation:
Eggleton, Ian, Stephen Penman, and John Twombly. "Accounting Changes and Stock Prices: An Examination of Selected Uncontrolled Variables." Journal of Accounting Research 14, no. 1 (Spring 1976): 66-68.
Volume: 14
Number: 1
Pages: 66-68
Date: Spring 1976