Pakistan Accounting Financial Reporting Setting

Regulatory bodies and authorities in Pakistan implemented a sound financial reporting environment for the development of the Pakistan economy gradually for the period. The implementation of IFRS started in January 2005, and the complete application of international financial reporting standards was completed in January 2014. The Companies Act of 2017 (formerly Companies Ordinance of 1984) implemented a financial accounting reporting application for all businesses in Pakistan. In Pakistan, all domestic and international listed companies follow the IFRS standards in their financial reporting. The regulatory bodies Security Exchange Commission of Pakistan (SECP), State Bank of Pakistan (SBP) and ICAP (Institute of Chartered Accountants of Pakistan), regulate the IFRS standards in Pakistan. The public listed and trading companies follow IFRS standards in their financial reporting. The ICAP is a professional and regulatory body formally notified for adopting the IFRS. The SBP body gets involved in monetary policy and financial market activities . Financial reporting followed by the IFRS standards better express the company’s value and raise the transparency and equivalence level. It also helps lead the investors toward future investment plans with a comparability of market performance worldwide. This comparability enhances the investors’ confidence with the help of accounting information analysis. This accounting information analysis and share price fluctuations affect investors’ investment decisions. When these changes influence investors’ decision power and responses, his accounting measure values are reflected as a quality measure value relevance (Juniarti et al., 2018). The application of IFRS standards has enhanced the value relevance of predictable accounting values and led a path for investors for their future investment plans (Alali & Foote, 2012; Nijam & Jahfer, 2018).

The Efficient Market Hypothesis Theory (EMH)

The Efficient Market Hypothesis Theory (EMH) is being used for the Capital market studies, which explains that the market would be considered efficient if the available firm accounting information is reflected on the current market share prices. Rendering to the Efficient Market Hypothesis (EMH) assumption, the rational investors decide on their future investments using fundamental and other company financial information, which the company declares in the form of financial reports to hedge their future risk in the capital market. After analysing all the required information, they decided whether they would buy or sell their stocks in the future. They move to retain their share if they have already bought them and at the same time realise that the required information about company stock is positive for company progress and benefit. Otherwise, if they get the negative signal for a stock future return, they shift to the selling decision of the stock (Singh, 2018).

The Market Value Relevance Theory

The theory of market value relevance is about the perception that accounting information summarises accounting numbers and measures that reflect market returns. Therefore, the financial statements represent the value relevant accounting measures and their association between the Firm’s financial reporting and share price or return value (Liu & Liu, 2007). The theory of market value relevance supports this research. It explains that these financial statements information will be evaluated by the investors only when that information will be helpful for their future investment’s decision. This theory also provides them with directions regarding their future returns/profits in the Stock Exchange Market. According to this theory, the accounting measures should be relevant, reliable and useful for investors.

The Signal Theory

The third underpinned theory of this study is Signal theory. The theory express motivation for external parties such as creditors and stakeholders through the company’s financial information. A Company is well aware of its financial position, future prediction, and condition compared to its external parties. So, the company financial reports are being used by the external parties to know about the company’s financial position. If the company provides insufficient financial reporting information to its stakeholders, stakeholders feel less secure regarding their future investments. It becomes the cause of the lower share value of the company. However, the information asymmetry could be decreased by delivering indicators to stakeholders or other external parties through reliable financial information regarding their future investments. And it could make the reason to lessen the uncertainty of the company’s future projections (Sadalia, Rahamani, & Muda, 2017).

Empirical Literature Review and Hypotheses Development

The current study deals with quality measure of accountiong information as value relevant.Kwon (2018) used survey panel data for large, medium and small (LMS) companies to observe the quality measures of accounting values of businesses listed on the Korean stock exchange. Results of the study found that the implication of book value, operating income, operation cash flow, earnings and cash flows changed significantly earlier and afterwards the application of IFRS.

In a study, the effectiveness of quality measures of accounting values of two countries, Germany and the United Kingdom, in earlier and afterwards IFRS application period. The researchers used both Ohlson and the modified model. According to the Ohlson model, there is a decline in the book value of shares in the quality measure. On the other side, in the modified model, the incremental values as earning and book values are higher and more effective for extended periods for UK firms than German firms. Although, the study found a higher profit margin for both countries after adopting, implementing, and applying IFRS. On the ground of the third model, the researcher additionally exposed a substantial rise in the relative predictive power of the book value of equities in the UK compared to the apparent effect of economic indicators on the value of profits in Germany (Elbakry, Nwachukwu, Abdou, & Elshandidy, 2017). (Alnodel, 2018) moderately agree with (Barth et al., 2001) and (Kwon, 2018) and is indifferent to a former study by (Elbakry et al., 2017). He observed the importance of the valuable accounting measure values in businesses that have both Pre IFRS application and Post IFRS application period. The research was conducted in a trio of European states. The study had implemented both multivariate and panel regression methodology. The study concluded that the voluntary application of IFRS standards did not expand the value measures of accounting information but showed a more association among accounting measures, stock prices and stock returns in earlier and afterwards IFRS application periods. However, the research described no substantial changes between Pre IFRS- and Post- IFRS application periods.

The literature shows that the value relevancy of financial statement measures is improved and reduced over time. The result of some studies showed that Post- IFRS adoption and IFRS transition period provides more value relevant and predictable financial statement measure values (Beisland & Knivsflå, 2015; Elshandidy, 2014; Outa, Ozili, & Eisenberg, 2017). On the contrary, the contradicting evidence also found in other research that there existed no perfection in value relevant financial statement measures after the adoption of IFRS standards (Gordon, Jorgensen, & Linthicum, 2008; Paulo, Girão, Carter, & Souza, 2013). Several studies have shown that value relevancy of an accounting measure and the equity book value had improved in the post-IFRS adoption and implementation period (Kargin, 2013; Nijam & Jahfer, 2018). Another study showed that the equity book value did not improve. Value relevancy of cash flow measure had improved after implementation of IFRS standard. (Prihatni, Subroto, Saraswati, & Purnomosidi, 2016) argued that cash flow had been considered a more value relevant financial measure in the pre- IFRS adoption period. However, these results demonstrate that other value relevance accounting information proxies affect the share price. Earlier research conducted in Pakistan did not combine firms detailed aspects as control variables, although these factors have a significant impact on value relevance (Asif, Arif, & Akbar, 2016; Rashid, Amin, & Farooqui, 2012; Shahzad, Zaheer, & Anees, 2013). Also, these studies incorporated a nominal sample size; hence, their results might not be comprehensive. So above research gap needs additional study to evaluate the perception of stockholders in Pakistan. The Cash flow and ROE, in addition, to control variables such as Size and Leverage which were not being investigated by any prior researcher for Pre & Post IFRS application and Transition regime period in Pakistan (Dang, Hoang, & Tran, 2017; Shamki & Rahman, 2013).

Based on the prior empirical literature on the value relevance of earnings, Book value, cash flows and ROE, the following hypotheses are developed:

H1: The value relevance of earning, the book value of equity, cash flow per share, and ROE significantly affect market share price in the pre- IFRS application period.

H2: The value relevance of earning, book value of equity, cash flow per share, and ROE has a significant effect on the market share price in the post- IFRS application period.

H3: The value relevance of earning, book value of equity, cash flow per share, and ROE has a significant effect on the market share price in the transition regime of IFRS.

Valuation model

For this study, the generalized (Ohlson, 1995) valuation model is being applied to access the nexus between valuable accounting values and share price measures. Ohlson’s price model outlines the firm value as a function of the book value of equity and earnings. This research has also combined the Cash flow per share and ROE as another valuable accounting measure and earnings and book value of equity. Most of the empirical literature has examined the valuable measures of Earnings, Book value per share and Cash flow per share by using Ohlson (1995) price model (Gan, Chong, & Ahmad, 2016; Mirza, Malek, & Abdul-Hamid, 2020; Nejad, Ahmad, & Embong, 2017). Earnings (EPS) are designed as ratios that express the company’s profit by deducting the preference dividend. The book value per share (BVPS) has measured total equity divided by the total no. of outstanding shares (Beisland & Knivsflå, 2015). The cash flow per share (CVPS) is designed by net cash flow value divided by the total number of outstanding shares (Prihatni et al., 2016) Return on equity (ROE) ratio is intended by net profit divided by shareholder’s equity and multiplying by 100 (Amahalu et al., 2017). The dependent variable is designed as the market value of the share price. Its share price takes its closing stock price (Menaje, 2012). The market share price is considered the year ended value of the Firm. According to the earlier research, this paper also regulates firm-specific variables, i.e. firm size and leverage (Bepari, Rahman, & Mollik, 2013; Mirza et al., 2020). To test the nexus among EPS, BVPS, CVPS, ROE and market share price (MP) through hypotheses HI, H2, H3. An econometric model is given below:

$\mathit{M}\mathit{P}\mathit{i}\mathit{t}\mathbf{ }\mathbf{ }= \mathit{\beta }0 + \mathit{\beta }1\mathit{E}\mathit{P}\mathit{S}\mathbf{ }\mathit{i}\mathit{t} + \mathit{\beta }2\mathit{B}\mathit{V}\mathit{P}\mathit{S}\mathbf{ }\mathit{i}\mathit{t} + \mathit{\beta }3\mathit{C}\mathit{V}\mathit{P}\mathit{S}\mathbf{ }\mathit{i}\mathit{t} + \mathit{\beta }4\mathit{R}\mathit{O}\mathit{E}\mathbf{ }\mathit{i}\mathit{t} + \mathit{\beta }5\mathit{D}\mathit{E}\mathit{R}\mathbf{ }\mathit{i}\mathit{t} + \mathit{\beta }6\mathit{F}\mathit{S}\mathbf{ }\mathit{i}\mathit{t} +\mathit{D}\mathit{u}\mathit{m}\mathit{m}\mathit{y}\mathbf{ }\mathit{Y}\mathit{e}\mathit{a}\mathit{r}\mathit{s}\mathbf{ }\mathit{i}\mathit{t} + \mathit{\epsilon } \mathit{i}\mathit{t}$

MPit = Market share price of non-financial company i for period t-the year ended share value.

EPSit = Earnings per share of non-financial company i for period t.

BVPSit = Book value of equity of non-financial company i for period t.

ROE it = Return on equity of non-financial company i for period t.

CVPSit = Cash flow per share of non-financial company i for period t.

DERit = Debt ratio of non-financial company i for period t.

FSit = Firm Size of non-financial company i for period t.

Dummy Yearsit = Years of non-financial company i for period t.

$\mathit{\epsilon }$ it = Other factors which influence on value relevant financial statements information.

Sample Selection

For estimation, secondary data has been taken from the audited published annual reports of non-financial firms of Pakistan. The other secondary sources are used for data collection, such as business recorder, state bank of Pakistan (SBP) and Pakistan stock exchange (PSX). The Pakistan Stock Exchange non-financial companies’ data have been taken for the analyses by excluding those companies whose data is not available for 2001 to 2018. The purpose of chosen non-financial companies is to compute ratios (equity book value, earnings per share, cash flow per share, return on equity, leverage) of the non-financial sector. 2001 to 2018 has been collected, interpreted, and analysed. The research period from 2001 to 2004 represents to Pre IFRS era, and since 2005 to 2008 represents the Post-IFRS era and then ten years’ data from 2009 to 2018 represents the transition period of IFRS in findings. This period of the study is chosen based on those companies. Those data is entirely available during this period of study. In PSX, there are 34 Sectors in which different companies exist. But this study includes only those non-financial companies whose data are available for eighteen years of this period. So, those companies are excluded from the data analysis with values missing for any study variable for eighteen years to get an appropriate result finding. The targeted sample is about 41 non-financial companies of the Pakistan Stock Exchange (PSX). This paper used the GLS-regression, correlation, Fixed or random-effect analysis method.

Correlation Analysis

In the study analysis, Pearson’s correlation coefficient test is being applied to satisfy the regression assumption. By just having a look at the findings of Table 2, The debt ratio has insignificant negative relation with Price, EPS, BV, CF, ROE and Size. In contrast, ROE has an insignificant positive relation with Price, BV, CF and Size. The Pairwise correlation overall shows significant relationships among variables. Multicollinearity is not considered a severe problem in OLS regression if the value is smaller than 0.8 (Hair, 2009).

The reason for conducting this research study is to define the market-share price fluctuations and trends. After applying the suitable data transformation, the GLS regression analysis, fixed-effect model, random effect-model and Hausman-specification test have been run. In Table 12; Table 9; Table 6 (see Annexure 1), the GLS regression analysis result findings conclude that the Pre IFRS, Post IFRS and transition period have regression values of 80%,82%, and 87%, respectively. Both Post IFRS and transition periods have higher R-square values, showing that these periods have more relevant financial measures than pre- IFRS. After the GLS Regression, the Hausman test is applied to regulate the fitted panel data model for all periods (Pre IFRS, Post IFRS, transition period). The Hausman is applied for deciding whether a fixed or random effect model is appropriate. According to Table 14; Table 11; Table 8 (see Annexure 1), the findings reject the Hausman test null-hypothesis and accept its alternative hypothesis as the Probability value (P-value) of chi-sq. Statistics is lower than “P<0.05”, which represents that the fixed-effect model is more appropriate than random- effect model for all research periods (Pre IFRS, Post IFRS and transition period). The research findings support the Post IFRS application and transition regime period as these periods show more value relevant financial reporting measures as useful for investors.

So, the research test analysis findings conclude that the research study null- hypothesis H1and H2 will be rejected. While H3 null hypothesis will be accepted as the value relevance of financial reporting measures information has a more significant influence on the market share price in the transition period. The past literature supports the research conclusions that the quality measures of accounting values as value relevance are more appropriate and useful for investors in the Post-application period of International Financial Reporting Standards (IFRS) (Alali & Foote, 2012; Juniarti et al., 2018; Kargin, 2013; Outa et al., 2017).

In Table 3, the Fixed effect model findings show that with the 1-rupee increase on average in BV, CF, ROE and debt ratio, the share price increases to about 0.75, 2.52 and 2.32values. While on the other side, with the 1-rupee increase on average in EPS and size, the share price decreases to about respectively with 2.58 and14.23 values. The significant variables are considered to have a P-value less than 0.05. In this research analysis, the 5% significance is being used. According to the 5% significance level, the research findings show a significant effect of EPS, BV, CF, and ROE on the share price in pre- IFRS. While the other variables, Debt ratio and size, have an insignificant influence on Share price with P-value more significant than “P>0.05”. The EPS has a significant negative influence, while the size variable has an insignificant negative impact on the share price. The previous research findings support these findings (Glezakos, Mylonakis, & Kafouros, 2012; Sharif, Purohit, & Pillai, 2015). The Factor of Coefficient of Determination value of R-squared explains how much variation in the dependent variable has been clarified by the result values of the explanatory variables. It is explained by the EPS, BV, CF, ROE, Debt ratio and size of listed Non-Financial Firms of PSX. The Factor of Coefficient of Determination value of R-squared explains the variation of 82% in the dependent variable for Pre- IFRS period. The analysis test measure of Adjusted R-Squared is a measure of the proportion of variation, which explains those independent variables that support to explain the dependent variable. Here in this research study, the value of Adjusted R-Square is about 81% less than R-Squared. The F-statistic measure of goodness of the model is lower than 0.05. It means that the model is a perfect fit. The Durbin-Watson statistics value is 2.6, indicating that data is almost free of autocorrelation. Standard-Error of the Estimates measures the observed average distance that drops from the regression line. The lower value is well fitted for the model. This value also estimates the average units of the response variable to know how wrong the regression model is. The Standard-Error of the Regression average distance of the figures points on the fitted line is about 19.48% body fat which is accepted. The Schwarz Criteria is about a measure of model selection in analysis. The lowest value of Schwarz Criteria is considered suitable for the best model. This criterion expresses the closest points of the model and the parameters used in the model. The Schwarz Criteria, which measure model selection in analysis, is 12.17 in Table 3. It is considered to be suitable for the model.

In Table 4, the Fixed effect model findings show that with the 1-rupee increase on average in BV, CF and ROE, the share price increases to about 0.206, 4.03 and 1.89 values. While on the other side, with the 1-rupee increase on average in EPS, Debt ratio and size, the share price decreases to about respectively with 1.19, 49.47 and 8.23 values. According to a 5% significance level, the research findings show a significant positive effect of CF and ROE on the share price in Post IFRS. While the other variables, BV, EPS, Debt ratio and size, have an insignificant negative influence on Share price with a P-value more significant than “P>0.05”. The previous research findings support these findings (Beisland & Knivsflå, 2015; Chalmers, Clinch, & Godfrey, 2011; Khanagha, 2011). The Factor of Coefficient of Determination value of R-squared explains variation above 90% (R>90%) in the dependent variable for Post IFRS. In contrast, the value of Adjusted R-Square is about 89% less than R-Squared.

In Table 5, the Fixed effect model findings show that with the 1-rupee increase on average in EPS, BV, CF, ROE, Debt Ratio and Size, the share price increases to about 0.12 0.65, 0.59, 0.64,1.21 and 17.3 values. According to the 5% significance level, the research findings show a significant positive effect of BV, CF and ROE on the share price in the transition period. While the other variables, EPS, Debt ratio and size, have an insignificant positive influence on Share price with a P-value more significant than “P>0.05”. The previous research findings support these findings (Khanagha, 2011; Prihatni et al., 2016; Sharif et al., 2015). The Factor of Coefficient of Determination value of R-squared explains 93% variation in the dependent variable in the IFRS transition period. The test measure of Adjusted R-Square, which measures the proportion of variation, is about 91% less than R-Squared.