Quality of Financial Reporting Premium and Equity Returns

Abstract

Financial statements published by a company at the end of every financial year serve three purposes: they inform, they help control and they help plan. The basic aim of transparent disclosure of accounting information is to assist the resourceful allocation of capital in the economy as they improve the investment and financing decisions. Reliable financial statements provides less biased performance measures and market efficiency also improved because transparent disclosure of accounting information reduced information asymmetry at lower cost which effects market performance. This study investigates the assets pricing mechanism in Pakistani equity market by using monthly data of equity prices from 2007-2012.To explore the joint effect of size, market and new factors quality of financial reporting by using Three Factor Model of Fama and French .Results shows that FRQP is giving negative returns with less risk but size and market premium have negative returns with higher risk. All portfolios showing negative returns mean they were in loss, so market was in decline stage.For future this study converse that information asymmetries can be reduced by transparent disclosure of accounting information because business investment strategies are affected by financial disclosure.From two pass regression we  further conclude that from past beta we can’t predict future returns because all results are insignificant so it means market price the quality of financial reporting of today’s information but it doesn’t not effect on future returns. Findings of the study also shows that explaining power of our proposed model is also better as compared to conventional CAPM So investor should carefully and diligently use these factors in designing their investment, financing and valuation strategies.

Keywords: Agency Theory, Arbitrage Pricing Theory, Capital Assets pricing theory, Fama and French Three Factor Model, Signaling theory, Quality of financial reporting.