The role of stock exchange efficiency in firm performance and earnings quality: evidence from the MENA region

This thesis examines the association between stock exchange monitoring and both firm performance and the quality of reported earnings for publicly listed firms from 16 economies across the Middle East and North Africa region (MENA). Agency theory suggests that efficient monitoring mechanisms have an important role to play in enhancing operating performance and the quality of reported earnings. Like other external mechanisms (i.e. takeovers, analysts following, banks, and institutional ownership), stock exchanges, as external monitors, perform monitoring activities that increase shareholders’ ability to evaluate managerial performance, and put in place effective managerial incentive schemes that are designed to motivate managers to act in the best interests of the shareholders, improve firm performance and enhance the quality of reported earnings. This suggests that the significant monitoring role of stock exchanges enhances market efficiency. Thus, it builds upon the association between stock exchanges monitoring and efficiency; as stock exchange monitoring improves, stock exchange efficiency increases. Using 15,295 (firm performance model) and 8,383 (earnings quality model) firm-year observations between 2001 and 2010 indicate that stock exchange efficiency is positively associated with firm performance, and negatively associated with the absolute value of abnormal accruals (a proxy of earnings quality). Additional tests comparing the results of more efficient exchanges with less efficient exchanges suggests that firms listed on more efficient stock exchanges have better performance and higher earnings quality (lower accruals) than their counterparts listed on less efficient stock exchanges. Additional analyses is performed to examine whether the association suggested by the main results continue to be evident in the presence of other factors shown in prior research to impact on firm performance or earnings quality (i.e. investor protection, legal origin, internal mechanisms, regional attributes, and the instability of economic and political events). Overall, empirical evidence supports the expectations, implying that the association between stock exchange efficiency and firm performance becomes stronger in countries with greater investor protection, a common law tradition, and high income levels. In contrast, the association between stock exchange efficiency and performance appears not to be influenced by the strength of internal governance and whether the firm operates in the oil sector. With regard to earnings quality, however, the results indicate that the association between stock exchange efficiency as an external monitoring mechanism and earnings quality is not affected by other factors. Fundamentally, the results of this thesis are consistent with the extant literature that suggests associations between monitoring mechanisms in general, external mechanisms in particular and both firm performance and earnings quality. This indicates that as stock exchange monitoring efficiency increases, firm performance and earnings quality improves. This thesis contributes to the extant literature on the significant role of stock exchange monitoring. Examining stock exchange monitoring adds another dimension to stock exchange efficiency. Further, it expands our understanding of the effectiveness of stock exchange monitoring role as an external mechanism in mitigating agency problems leading to improved firm performance and earnings quality.