Value Relevance of Accounting Information in Explaining Stock Returns in Sri Lanka

Abstract

The value relevance of accounting information is an important area in accounting researches. However the literature provides contradictory conclusions on the value relevance of accounting information in different stock exchanges and there is a very limited knowledge in this regard in Sri Lankan context. Hence this study endeavored to investigate the value relevance of accounting information in explain stock returns considering three traditional accounting performance measures: Earnings Per Share (EPS), Return on Equity (ROE) and Return on Investment (ROI) as the proxy for accounting information. The study was conducted with the hypothesis that the traditional accounting performance measures are significant in explaining stock returns in Sri Lanka. A sample of 1695 firm year observations were used for the study covering 113 companies in Colombo Stock Exchange for fifteen years period from 1999 to 2013. This study used Easton and Harris (1991) formal valuation model. Panel data regression analysis technique was applied to test the relative information content of each performance measure to identify the best performance measure which could explain the stock returns in Sri Lanka. The study revealed that the EPS and ROI are significant performance measures and the EPS is the best performance measure which could explain the significant variations of stock returns in Sri Lanka. The results suggest that the market participants in the Colombo Stock Exchange should pay more attention on EPS and ROI. Meantime they must consider other determinants to develop their investment strategies. Keywords: Earnings per share, Return on equity, Return on investment, Sri Lanka, Stock Return, Value Relevance