Relationships between Stock Prices and Accounting Information

As one of the main purposes of financial statements is to provide relevant information for investors, relationships between share prices and accounting variables have been widely researched. Early studies focus mainly on earnings, but attention has turned in recent years to valuation models that include the book value of the equity. Many of these studies cite the residual income model as their theoretical base and, with the growing emphasis on shareholder value, residual income measures are more commonly used in the business community to track financial performance. Given such trends, this paper reviews the theoretical background of the residual income model and discusses results of empirical studies that use it. The study finds that the two main accounting variables can usually explain a substantial part of the variation in share prices, and it also identifies a number of issues that remain unresolved. These findings should be of interest to other researchers, and to managers and investors who currently use, or are planning to use, residual income to monitor business performance