A Review of Capital Market Research

Capital market research in accounting is based on the relationship between the capital market and financial statement. CMR emerged in accounting literature during the 1970's. Prior to that majority of accounting literature deemed it futile to expect a fairly presented financial position if the aggregates are represented by varying components such as historical cost, actual value, depreciated historical cost, LIFO (Chambers, 1976) Therefore a lot of researchers at the time were focused on advocating for a paradigm shift from historical cost accounting with replacement cost, realizable value, discounted present value and historical index costing(Hendriksen ,1965) citing pathological cases such as bankruptcies, accounting scandals, takeovers or subsequent asset revaluations.

Balls and Brown (1968) on the other hand deemed it necessary to support accounting theory with empirical research and consideration of selection bias. In their research paper 'An Empirical Evaluation of Accounting Income Numbers' they assessed the information content of accounting disclosure by evaluating the aggregate effect of unexpected earnings on abnormal returns and found that 80-90% of earnings is anticipated by inventors due to multiple sources of  financial information. This indicates that annual accounting numbers are not a particularly timely source of information to the capital markets. This research strongly relies on the semi-strong form of market efficiency which asserts that the market reacts swiftly to impound all publicly available information into the share price (Fama,1969).

Beaver (1968) circumvents the problem of specifying an earnings expectation model by examining the variability of stock returns and trading volume around earnings announcements. Beaver hypothesizes that the earnings announcement period is characterized by an increased flow of information compared to a non-earnings announcement period. He uses return volatility to infer the flow of information. The evidence supports Beaver's hypothesis.

The principles of capital market research holds that earnings are oriented toward the interests of shareholders and information about earnings and its components is the primary purpose of financial reporting.The capital market research topics of primary interest to researchers currently appear to be tests of market efficiency with respect to accounting information, fundamental analysis and value relevance of financial reporting  (Watts, 2001).

The belief that “price convergence to value is a much slower process than prior evidence suggests” ( Frankel and Lee, 1998). The accounting literature draws inferences about market efficiency from two types of tests: short- and long-horizon event studies and cross-sectional tests of return predictability or the anomalies literature. Event studies, which constitute the bulk of the literature, include the post-earnings-announcement drift literature

The studies were important in refuting the then prevailing concern that the historical cost earnings measurement process produces meaningless numbers. Second, these studies introduced positive empirical methodology and event study research design to the accounting literature. The early capital markets research amply demonstrated the benefits of incorporating the developments from, and contributing to, the economics and finance literature. Finally, the studies helped dispel the notion that accounting is a monopoly source of information to the capital markets.

Some of the arguments against the importance of capital market research indicate that a majority of the findings are neither novel nor useful to the accounting profession. In addition critics assert that there is mounting evidence of capital market anomalies, which suggests that capital markets might be inefficient and that early research did not perform statistical tests comparing alternative performance measures.