The Declining Value Relevance of Accounting Information and Non-Information-Based Trading: An Empirical Analysis

Abstract

Recently, a growing body of literature has suggested that financial statements have lost their value relevance because of a shift from a traditional capital-intensive economy to a hightechnology, service-oriented economy. These conclusions are based on studies that find a temporal decline in the association between stock prices and accounting information (earnings and book values). This paper empirically tests a theoretical prediction arising from the Noisy Rational Expectations Equilibrium model that suggests that the decline could be driven by non information based (NIB) trading activity, because such trading reduces the ability of stock prices to reflect accounting information. Specifically, Dontoh et al. (2004) show that when NIB tradingincreases, the R-squares of a regression of stock price on accounting information declines. Our empirical tests confirm this prediction; i.e., the decline in the association between stock prices and accounting information as measured by R-squares is driven by an increase in NIB trading.

Keywords: Noisy rational expectations equilibrium, Non-information-based trading, Value relevance