The relationship between accounting numbers and returns: some empirical evidence from the emerging market of the Czech Republic

Generally, stock prices reflect future expectations of earnings, whereas accounting data reflect past performance. This paper attempts to discover the relationship between accounting data and market price returns of the companies listed on the Prague Stock Exchange (PSE). The Prague Stock Exchange was established in 1993 and provides an opportunity to make a comparison between a newly established market and the findings of studies of established markets. There has been a wealth of publications and accounting research studies on developed markets. Generally, accounting attributes are thought to be relevant because they tend to be contemporaneously statistically associated with stock prices. Some studies have suggested, and empirically tested, that stock prices lead earnings (e.g. Collins et al., 1987; Kothari, 1992; Kothari and Sloan, 1992; Kothari and Zimmerman, 1995). This study tests the existence of such a relationship in the Czech capital market, relying partially on the methodology proposed by Kothari and Sloan (1992) and Kothari (1992). This paper investigates whether there is a statistically significant permanent relationship between returns and accounting data on the Czech market. The study was conducted using accounting earnings and stock prices during the period 1993–8. The empirical evidence here suggests that a similar relation exists on the emerging Czech market. The relation is statistically significant for measurement windows of one year and longer. The increase in the mean response coefficient, reported later in this study, suggests that one-leading-year returns are as important as contemporaneous returns in terms of their sensitivity to annual earnings changes. However, one cannot infer with a degree of confidence that the Czech capital market views earnings changes to be largely permanent, which would be consistent with the time-series properties of annual earnings.