Price Divergence from Fundamental Value and the Value Relevance of Accounting Information

Abstract

By employing two alternative measures of fundamental value, we re-examine the value relevance of accounting information over time. Consistent with some recent studies (e.g. Dontoh et al. 2007), we do not find evidence on the temporal decline in R-squares of conventional value-relevance regressions when the stock price is replaced by these measures as the dependent variable. Further, our results show that the divergence between fundamental value and the prevailing stock price: (1) increases over time and (2) is associated with measures of noise trading and other arbitrage risks and costs. Additional analyses also reveal that proxies measuring the extent of noise trading increase over time, consistent with Dontoh et al. (2004). Overall, we do not find evidence that there is a loss over time in the value relevance of accounting information with respect to fundamental value. More importantly, we show that measures of price divergence are associated with noise trading as well as other arbitrage costs and risks (such as transaction costs and information uncertainty) that prohibit market prices from converging to fundamental values.

Keywords: value relevance, market efficiency, R-squares, fundamental values

JEL Classification: G12, G14, M41