Studying the relationship between profit quality and stock liquidity in Tehran Stock Exchange

Accounting Master's Thesis

The present study was conducted to provide evidence to clarify the relationship between profit quality and stock liquidity, as well as to evaluate the impact of profit quality on stock liquidity. In this research, 96 companies admitted to the Tehran Stock Exchange in the 5-year period of 1387-1392 (with one year in advance) have been investigated as a statistical population. The independent variable in this research is the quality of profit, which is measured by two indicators (quality of accruals and smoothing of profit). To calculate the quality of accruals, Dichau profit quality model and Lewis quality model were used for profit smoothing. Also, in order to measure the liquidity of stocks, seven liquidity variables that are dependent variables were used, which are: percentage of free floating shares, number of trading days, transaction waiting time, trading volume, stock turnover, stock trading value and stock turnover. The float and control variable of this research is the stock market price. In order to test the hypotheses, the regression model and combined data have been used.

The results of the sub-tests indicate the quality of accruals and the inverse and significant relationship with the percentage of free floating shares and transaction waiting time; It is directly related to the number of trading days and stock turnover; In the event that sufficient evidence was not found to indicate a significant relationship between the quality of accruals and the volume of transactions, the value of transactions and the circulation of free floating shares.

At the same time, the results showed that profit smoothing has an inverse and significant relationship with the number of trading days; It has a direct relationship with stock turnover, in the event that sufficient evidence was not found to show a significant relationship between profit smoothing and the percentage of free floating shares, trading volume, transaction value, transaction waiting time and free floating stock turnover.

Key words: profit quality, stock liquidity, stock exchange

Introduction

Investment in capital markets, It is one of the essential things in the process of economic growth and development of any country. The stock exchange can be referred to as a symbol of the capital market. In order to maintain and increase the value of their investment portfolio, investment managers, portfolio managers and other natural and legal persons who deal with stock and other financial assets in this market should study various factors affecting the performance of their portfolio of financial assets under different economic conditions and try to invest their financial resources in financial assets that have the highest return and the least risk for them. (Talib Niya, 2009).

Most of the investors in the investment stage consider liquidity as an investment advantage, and invest in stocks (if other conditions are relatively stable) that have high liquidity. The lower the liquidity of a share, the less attractive it will be to investors, unless the owner receives a higher return. Empirical evidence shows that the factor of illiquidity in investments can play an important role. In other words, some investors may need their financial resources quickly, in such a situation, liquidity can be very important. Liquidity means the speed of converting investments into cash. In other words, liquidity simply means the ease of buying and selling shares.

Many criteria for liquidity have been discussed in previous studies. In one category, these criteria can be divided into two categories: informational criteria and transactional liquidity criteria (Rahmani, Hosseini, Rezapour, 2019). Regarding the information criteria, it is believed that they react directly to the information, and the timely disclosure or non-disclosure of the required and expected information leads to changes in these criteria. Trading criteria are more influenced by investors' behavior.

Also, in past studies, the effect of several factors on these criteria has been studied. Factors such as cash profit, disclosure quality, company size, yield volatility are among these factors. By studying and examining these studies, the factor of information asymmetry cannot be ignored. Because in most of these studies, the effect of the independent research variable on stock liquidity has been examined through the influence of the independent variable on information asymmetry. This discussion means how the effect of information asymmetry on liquidity is explained as follows.

The cost of market makers is divided into three parts: order process costs, inventory maintenance costs and incorrect selection costs. The costs of the purchase and sale request process (order) are costs that are directly related to the provision of marketing services and include items such as stock exchange membership, exchange space rental, computer costs, information service costs, and labor costs. Inventory holding costs are the costs that a market maker incurs due to his responsibility in providing investors with the immediacy of exchange (liquidity).

Incorrect selection costs are created because market makers may enter into transactions with people who have more information than them. In other words, the second party of the transaction has confidential information. To deal with this risk, market makers increase the gap between the proposed purchase and sale prices. In this way, they try to guarantee their financial security. Assuming that the quality of information disclosure is high and the companies take the initiative to disclose more and better information, the possibility of the existence of hidden information and, accordingly, the possibility of information asymmetry will be reduced, and market makers will evaluate the risk of wrong choice as low, as a result of reducing this risk, the liquidity of stocks and the market will increase.

On the other hand, in recent years, especially after the occurrence of financial scandals, a lot of attention has been drawn to the quality of profits. The quality of profit is a concept that has different aspects and therefore it has been defined in different ways. An important definition of earnings quality is based on earnings sustainability; earnings sustainability means the repeatability of current earnings. The higher the profit stability, the more the company has the ability to maintain and continue the current profits and the higher the profit quality. (Thaqafi, 2009)

1-2- Statement of the problem

The issue of the high cost of weak profit quality has long been the interest and controversy of academics and experts in the financial field. Arthur Levitt[1], the former head of the US Stock Exchange, considers the most important benefit of the high quality of accounting standards to increase liquidity and reduce capital costs.

The analytical model of those such as Keely[2] (1985) and Glaston[3], Milgrom[4] (1985) shows that information asymmetry increases the risk of incorrect selection cost for market makers. In response to the risk of incorrect selection, the gap between the proposed purchase and sale prices is increased by market makers, the expansion of this gap leads to a decrease in the liquidity of stocks, liquidity can affect the cost of acquiring capital. According to the evidence of Amihud [5] and Mendelson [6] (1986), investors intend to maximize their investment returns net of transaction costs and liquidity. Some investors include people within the organization such as managers, their analysts, and institutions that receive information from these people, have access to confidential news (Isley and O'Hara, 2004). Investors increase, and therefore the return of investors who do not have access to such information decreases. (Chang et al. 2009) As an example, Ghaemi and Watanparast (2004) have shown that in the Tehran Stock Exchange, the increase in information asymmetry between traders widens the range of the price offer for buying and selling shares. However, the issue of the difference in the bid price of buying and selling shares is rooted in the abnormal supply and demand flow. Unusual supply and demand arises as a result of confidential information; When there is bad confidential news, the stock supply increases and the selling price decreases. On the contrary, when there is good confidential news, the demand is high and the buying price increases. If there is no confidential information, the effects of public information available by market makers are reflected in the stock price. That is, when the market makers receive information, they direct the price to the appropriate level and as a result, unusual buying and selling does not take place (Rezazadeh and Azad, 2017).