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Firm fundamentals and stock prices in emerging Asian stock markets: some panel data evidence

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Abstract

The purpose of this paper is to investigate the direct link between firm fundamentals and stock prices in a set of emerging Asian stock markets using firm-level panel data. In doing so, we explore the relationship between firm-specific variations in stock returns and firm fundamentals in the context of a simple present value framework. We find that alternative proxies of variation in firm fundamentals—albeit at differing degrees—explain a significant part of firm-specific return variation in a majority of emerging markets in Asia. Findings are robust to the influence of other factors known to affect stock return volatility (e.g. firm size, stock turnover, and leverage). Overall results suggest that stock prices in a majority of the Asian emerging markets contain a significant amount of firm-specific fundamental information and are, therefore, not as murky as commonly thought.

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Notes

  1. For recent empirical evidence on the positive effect of country-level institutions (e.g., investor protection and the nature of the information environment) on the value relevance of accounting earnings and the informativeness of stock prices across countries see, for example, Cahan et al. (2009).

  2. Please refer to Table 1 for market-specific liberalization dates.

  3. As is discussed in Sect. 4.2, we lose the first annual observation for each firm in estimating firm-specific variation in fundamentals and therefore use at least 7 years (6 years for China) of accounting data in estimation. While we acknowledge that using more years of data arguably adds to the precision of estimates, given the scarcity of accounting data for emerging market firms, it worsens the problem of obtaining data for a statistically meaningful number of firms for each market-specific sample. Due to similar reasons, Morck et al. (2000) and Durnev et al. (2004a) use, respectively, at least 5 and 6 years of accounting data in estimating their firm-specific fundamentals variation.

  4. A common concern with accounting internationally, especially in environments where regulation is relatively weak, is a tendency for managers to smooth earnings by adopting various operating strategies and accounting policies (Leuz et al. 2003). Even if we cannot reject this possibility a priori in relation to our earnings data, cash earnings and sales are unlikely to be affected by this practice.

  5. Risk-free rates used for India and Malaysia are not available for a brief period towards the beginning of respective sample periods. Over such periods, we use comparable money market rates available from Datastream® as substitutes. Failing to find a suitable proxy risk-free rate for China over the study period, total returns are used in the estimation.

  6. Recently, Chang and Dong (2006) and Irvine and Pontiff (2009) have also used analogous measure of idiosyncratic fundamentals volatility in their analyses.

  7. As part of an unreported exercise, when we focus only on the majority of firms in each market having the same financial year, we get qualitatively the same results for all markets, except Malaysia. Apparent failure of the alignment procedure for the country is understandable considering the fact that, unlike that in other markets, the end of every month over the whole calendar year is the end of the financial year for at least a few firms listed on the Kuala Lumpur Stock Exchange. Such firms constitute about 50 % of initial Malaysian sample. Therefore, we decide to work with only a restricted sample of Malaysian firms with financial year ending on 31 December for our subsequent analysis.

  8. The system GMM estimator is especially suitable when the sample is relatively short and the dependent variable is persistent over time, which is also the case in our study. In addition, our volatility measures are likely to be endogenous in the sense that they may be related to firm-specific characteristics. Alternatively, there may also exist a common cause for firm-specific volatility of returns and cash-flows. Finally, the measurement errors in our constructed volatility measures represent another source of endogeneity. Pagan (1984) and Pagan and Ullah (1988) suggest using instrumental variables in estimation involving such variables to alleviate the effect of measurement errors.

  9. This implies that, for example, the two moment conditions E(X i,t−2 Δɛ i,t ) = 0 and E(X i,t−3 Δɛ i,t ) = 0 are collapsed into E(X i,t−2 Δɛ i,t  + X i,t−3 Δɛ i,t ) = 0. This strategy of reducing potential bias due to too many overidentifying restrictions is implemented using the “collapse” option available as part of the xtabond2 routine for Stata (Roodman 2009).

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Acknowledgements

We gratefully acknowledge the insightful comments and suggestions received from two anonymous referees. We also appreciate many useful comments from Craig Ellis, Girijasankar Mallik, Ludwig Reinhard and session participants at the International Colloquium on Business & Management (ICBM), Bangkok, 2007, the Asian/Nippon Finance Association Meetings, Yokohama City, Japan, 2008, and the Financial Management Association (FMA) Meetings, Grapevine, Dallas, Texas, 2008, on earlier drafts of the paper. The usual disclaimer applies to any remaining errors and omissions.

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  1. Faculty of Business, Economics and Policy Studies, Universiti Brunei Darussalam, Gadong, BE1410, Brunei Darussalam

    M. Arifur Rahman

  2. Department of Economics and Finance, University of New Orleans, New Orleans, LA, 70148, USA

    M. Kabir Hassan

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  1. M. Arifur Rahman
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  2. M. Kabir Hassan
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Correspondence to M. Arifur Rahman.

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Rahman, M.A., Hassan, M.K. Firm fundamentals and stock prices in emerging Asian stock markets: some panel data evidence. Rev Quant Finan Acc 41, 463–487 (2013). https://doi.org/10.1007/s11156-012-0316-x

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