Equity Betas, Accounting Fundamentals and Market Efficiency in Brazil

Abstract

This study presents an integrated approach on how financial statements might capture company risk and tests the derived accounting variables against equity betas. The intention is to offer a finance-theory-based framework to those financial statement external users that are interested in assessing companies' risks. Another goal of the article is to assess whether stock prices reflect fundamental risks as identified in the companies' financial statements. The assumption underlying this investigation is that although capital markets might not be efficient at all times, a certain level of efficiency can be identified if equity risk reflects fundamentals. To test the proposition, a Spearman's rank correlation was run both at company and portfolio levels. Data from sixty-two listed companies were gathered from 1995 to 2004. The setting for this test is the Sao Paulo Stock Exchange. Results show a reasonable association between the accounting variables chosen and equity betas, evidencing that market prices reflect companies' fundamentals. The results also confirm the predicted signals for all accounting variables, evidencing that the model discussed bellow may be used as a framework for assessing equity risk. This might be of particular interest to the task of estimating betas of unlisted companies.

Keywords: Equity Betas, Accounting Fundamentals, Residual Income, Business Risk

JEL Classification: G12, G15, M41, M47