The Declining Value†relevance of Accounting Information and Non†Information†based Trading: An Empirical Analysis

Recently, a growing body of literature has suggested that financial statements have lost their value†relevance because of a shift from a traditional capital†intensive economy to a high†technology, service†oriented economy. These conclusions are based on studies that find a temporal decline in the association between stock prices and accounting information (earnings and book values). This paper empirically tests a theoretical prediction arising from the noisy rational expectations equilibrium model that suggests that the decline could be driven by non†information†based (NIB) trading activity, because such trading reduces the ability of stock prices to reflect accounting information. Specifically, Dontoh, Radhakrishnan, and Ronen (2004) show that when NIB trading increases, the R2s of a regression of stock price on accounting information declines. Our empirical tests confirm this prediction; that is, the decline in the association between stock prices and accounting information as measured by R2s is driven by an increase in NIB trading.