2. Benchmarks as a tools for financial ratios interpretation.
One way of placing a company in its operating context is to compare its financial ratios with aggregate indicators for the economy or sector. These benchmark ratios may serve as characteristic values and thus provide a way of assessing the country or sector effect, i.e. the mean effect for all companies in the reference group. Analysts have at their disposal a number of sources of such benchmarks. Indeed, given the development of electronic financial information networks, industry-wide and economy-wide statistics are readily available. Information intermediaries such as Thomson, and products such as Worldscope, provide benchmarks for peer review that are regularly updated as new results are published.
But care should be taken when drawing inferences about 'mean effects' within a given country (or sector) using the commercial financial information services, because the benchmarks in question are often obtained from subsamples that have not been constructed for this purpose. Also, there is an important theoretical issue here. A ratio computed from meaningful sector aggregates (e.g. total cash flow from operations in the sector to total sales) is likely to differ substantially from the average ratio for the individual companies in the sector, and depend on the size distribution of firms, the growth of firms and other aspects of industrial structure. A more detailed critique of the misuse of ratios in international financial analysis can be found in Choi et al (1983).
A simple but effective approach to benchmarking is to plot performance against the median ratio. In the case of the three companies analyzed above, the relevant peer groups comprise the main industrial and consumer firms in Italy (Fiat), Germany (Volkswagen) and Sweden (Volvo), as the aim is to assess performance in the context of other firms domiciled in the same country. To establish upper and lower reference points, the ratio quartiles are also plotted. Figure 2 displays the results. It can be seen that, in 2001 and 2002, there were substantial numbers of Swedish and German firms that reported significant net losses. Against this background, we can also see that Volkswagen's ROE trend was not attributable to its German domicile, as its ROE moved from the upper quartile of German companies
Figure 2 Benchmarking return on equity
to below the median over the four years. Volvo, however, followed much the same trend as other Swedish companies. In contrast, Fiat's performance was particularly anomalous in the context of other firms based in Italy.
3. Financial analysis and the capital market
The relevance of financial disclosures, and corporate earnings in particular, varies from one stock market to another. In Europe, the harmonization process of the 1980s did little to iron out these differences. Research by Joos and Lang (1994) considered the effect of the accounting Directives on the relationship between earnings and stock prices, investigating other indicators as well, such as Return on Equity, the Price to Earnings multiple and the Book to Market ratio. Changes in the accounting environment seem to have had a minimal effect in capital markets at the time, as these authors report no evidence of convergence in the value-relevance of earnings and other accounting numbers after the implementation of the Directives into national legislation.
In the case of German firms, the investment analysts' association (DVFA) attempted to address these shortcomings (недостатки) by devising a formula to arrive at adjusted profit figures for use in market valuation. Other researches found that DVFA adjustments significantly increased the explanatory power of earnings in the period following the changes in German accounting law. In a study of London-based analysts, it was reported on the adjustments that are made for international accounting differences. They find that adjustments are often not made for many important differences, even though the regular publication of reconciliations (согласование) to IFRS and US GAAP provides more detailed information in this respect.
An important task undertaken by the financial analyst is to provide investors not only with 'superior' earnings per share (EPS) figures when the quality of reported figures is deemed to be low, but also with estimates of future EPS. For example, the forecasts made by a number of different analysts regarding the earnings of Nokia are summarized in Figure 3, which shows the average estimates given by IBES both for the year ahead (FYl) and two years ahead (FY2). A compa-rison with the average forward earnings for the S&P 500 firms is also shown.
Figure 3 Analysts' earnings forecasts, Nokia
It is sometimes argued that analysts' forecast errors (i.e. the difference between the forecasted earnings and the actual earnings that are reported at a later date) are too large for investors to rely on analysts' predictions (прогнозы). The evidence suggests, however, that analysts are able to provide estimates of future EPS that can assist in market valuation. Such forecasting requires a sense of where a business and its competitors are going, and the results of a survey carried out by Moyes et al. (2001) indicate international differences in the relative importance of the various factors taken into account. These authors point to a more international focus by the UK analysts and a greater reliance on guidance from management in the United States, but clearly the accuracy with which analysts are able to forecast EPS will also be affected by a number of other issues, as discussed below.
Forecasting will be more difficult when earnings are volatile (нестабильные), and the behavior of reported EPS will also be influenced by accounting practices that either smooth or exaggerate (усиливать) the underlying earnings behaviour. Figure 6 shows how the earnings of European firms are at their most volatile in Italy and at their least volatile in the Netherlands. Some researches demonstrate that analysts' earnings forecasts generally outperform naive forecasts but are typically optimistic and increasingly inaccurate the longer the forecast horizon. These researchers also find that analysts' forecasts are at their best for firms in the Netherlands and least successful in the case of firms in Italy. This is consistent with the volatility ranking in Figure 4.
The frequency and timing of financial disclosure also affect analysts' forecasts. Disclosure takes different forms, not only the legally required annual report but also additional mandatory disclosures to the capital market, interim reports for investors and other announcements such as preliminary earnings statements. As mentioned
Figure 4. Earnings volatility in Europe
Forecasting accuracy (точность прогноза) has also been found to vary with the complexity of the task. In particular, in countries where there is strong enforcement of accounting standards, which encourages managers to follow the prescribed rules, this seems to reduce analysts' uncertainty, which in turn leads to more accurate forecasts. Finally, differences between local and international accounting standards are also known to be related to the accuracy of analyst earnings forecasts, and some studies show that the adoption of IFRS is associated with a reduction in these prediction errors.
It is important to recognize that value relevance is likely to be conditional (видимо, зависит) on institutional conditions in the jurisdictions involved. In this context, the question arises, if the usual culprits (преступления) will cause financial disclosures to be less relevant to investors. Is the financial system bank-oriented, for instance? Is the government the source of accounting rules and regulations? Is the accounting system aligned (связана) with taxation? A useful approach in this respect is to consider the incentives (стимулы) related to these institutional factors and how these might predictably affect accounting income. For example, when governments establish and enforce national accounting standards, this is typically with representation from business associations, banks and employee organizations. At the firm level, this is reflected in stakeholder governance. Ball et al. (2000) contrast stakeholder and shareholder governance. Under the former, where payouts to stakeholders are likely to be more closely linked to accounting income than otherwise, managers will have greater discretion in deciding when gains and losses will be incorporated in accounting income, and direct communication with insider groups should solve the information asymmetry between managers and stakeholders. In contrast, under a shareholder governance model, where greater reliance is placed on external monitoring in the capital market, there will be more demand for timely public disclosure, and conservative earnings computation should make managers more immediately accountable.
Timeliness and conservatism are key properties of accounting numbers that differ between accounting regimes. Timeliness is the extent to which current accounting income incorporates economic income, which can be proxied by the change in market value of equity. Conservatism is defined as the extent to which losses are recognized more quickly than gains, i.e. that unrealized decreases in asset value are written off immediately whereas unrealized gains are not recognized. Figure 5 shows the relationship between market price changes expressed as returns and earnings expressed as an earnings yield. Accounting conservatism is indicated by a steeper slope for bad news in the market (a negative return) relative to good news (a positive return). The situation in Germany is of particular interest. It has been widely presumed that accounting in Germany is particularly conservative because increases in asset values cannot be written into the financial statements. Also, in the past, provisioning has provided ample discretion to smooth earnings by reducing income in good years.
Figure 5 Accounting conservatism and timeliness
However, Germany should no longer be characterized as an extremely conservative regime in this market-based analysis.
In Japan, another typical insider system, accounting is neither timely nor conservative. Earnings do not incorporate economic income at all, the negative and positive slopes being close to zero. At the other extreme, in the United States (a typical outsider system), accounting is seen to be more timely and the most conservative.
In conclusion, international comparison of financial statement information requires a good understanding of the way in which judicial systems, securities laws and ownership structures can create incentives that influence the managers of firms in the way they draw up their financial statements, and lead to contracting and monitoring demand for credible accounting information. In this context, firms in countries with high quality judicial systems reflect bad news in reported earnings faster than firms in countries with low quality judicial systems, that strong public enforcement of securities law discourages optimism by slowing recognition of good news in earnings, and that diffuse equity holding that separates the ownership of capital from the management of capital is also consistent with more conservative earnings. However, as firms increasingly exploit the integrated global market, these national accounting differences tend to have less effect. But the differences still exist: foreign firms that cross-list in the USA still show more evidence of earnings management, and less evidence of the timely recognition of losses than their counterparts in the USA .