Accruals,Cash Flows,and Equity Values

We find, as predicted, that the differential ability of accrual and cash flow components of earnings to help forecast future abnormal earnings and the persistence of the components result in the components having different valuation implications. We base our tests on Ohlson (1999) applied to fourteen industries. We find: (1) Accruals and cash flows aid in forecasting future abnormal earnings incremental to abnormal earnings and equity book value. (2) Accruals and cash flows provide explanatory power for equity market value incremental to equity book value and abnormal earnings. (3) There is evidence that accruals and cash flows valuation coefficients are consistent with the Ohlson model.     

Discussion of “Using accounting information for consumption planning and equity valuation”

This paper discusses Yee (2007), who investigates the role of accounting information for consumption planning and equity valuation. Higher earnings quality increases investor welfare and ex ante stock prices as well as the weight on earnings in valuation equations based on both cash flows and earnings. The former is due to improved consumption smoothing through more informed production choices, while the latter is due to the impact on the relative information content of current cash flows versus earnings about future cash flows.     

Detecting news in aggregate accounting earnings: implications for stock market valuation

How much news is there in aggregate accounting earnings? I provide evidence that earnings changes at the stock market level are correlated with new information about not only expected future cash flows but also discount rates. A comprehensive investigation of the link to discount rates reveals that aggregate earnings changes are tied to news about all components of the expected future stock market return, i.e., the real riskless rate, expected inflation, and the expected equity risk premium. Over the sample period studied, cash flow news and discount rate news in aggregate earnings changes covary positively and have offsetting impacts on stock market prices. As a result, stock market prices appear to be insensitive to aggregate earnings changes. The findings highlight the importance of separating cash flow news from discount rate news when evaluating the information content of accounting earnings at the stock market level. Overall, my study sheds new light on the informativeness and relevance of accounting earnings for valuation at the stock market level.     

Differences in the valuation of earnings and book value: Regulation effects or industry effects?

This paper uses a valuation framework on a sample of firms from four European countries (France, Germany, Netherlands, and United Kingdom) to examine how income, accruals, and book value of equity are perceived by the respective capital markets. Our model includes adjustments for industry effects and taking into account the linear information dynamics of the accounting variables posited in the Ohlson model. Consistent with previous researchers, we find that both earnings and book value of equity have valuation implications and that there is significant dispersion in the country-specific and industry-specific valuation multiples. However, when using accounting variables to forecast market values we find that industry-specific valuation multiples reduce forecasting error more than country-specific ones.     

The use of earnings and cash flows in investment decisions in the U.S. and Mexico: Experimental evidence

In this study, we investigate which of two accounting performance measures, earnings or cash flows, is used more in valuation decisions by non-professional investors in the United States and in Mexico. This issue is relevant for the Mexican Stock Market (Bolsa Mexicana de Valores) because the Bolsa's growth has stagnated compared with markets of other Latin American countries. Results of the study reveal that the majority of participants in the U.S. rely on earnings while the majority of participants in Mexico rely on cash flows. Results also suggest that the users’ predisposition can be dysfunctional to the extent that they do not consider using the other accounting measure, even when doing so made it easier to arrive at the correct valuation result (i.e. they did not choose to use the more persistent and therefore easier to forecast accounting measure). However, results are mixed for participants using earnings, since we document a higher chance of forecasting errors for participants in both countries when using earnings rather than cash flows in their calculations for the failure of these participants to adjust earnings for depreciation.This study extends the existing international literature by documenting a country-specific predisposition to use cash flows or earnings as a valuation tool by non-professional investors. Moreover, this study also shows that this predisposition can be dysfunctional, leading participants to make incorrect valuation decisions as a result of their failure to consider the differential persistence of the two accounting measures presented in the experiment.     

Searching for value relevance of book value and earnings: a case of premium versus discount firms

We examine the premium/discount firm characteristic that fundamentally affects the value relevance of two key accounting line items, earnings and book values. We argue that from the perspective of both the residual income and option-style valuation models, the relative valuation roles of earnings and book values differ fundamentally between firms that trade at a premium vis-à-vis discount to book value. We find that book values play a significantly more important role in equity valuation than earnings when firms trade at a discount. We also find that other known influential conditions, such as the sign of earnings (Collins et al. in Acc Rev 74(1):29–61, 1999) or the relative levels of earnings and book value (Burgstahler and Dichev in Acc Rev 72(2):187–215, 1997), become inconsequential when the premium/discount condition of the firm is controlled for. The discovered relationships between the relative valuation roles of book values and earnings and the discount/premium characteristics of the firm are robust to the effect of time, information environment and the industry of the firm.     

Incentive Contracting and Value Relevance of Earnings and Cash Flows

Accounting performance measures such as earnings and cash flows are useful for both valuation and performance evaluation purposes. However, little evidence exists on whether there is any association between these two roles. In this study, we provide large sample empirical evidence that the value relevance of earnings explains a significant amount of the cross‐sectional variation in the pay‐sensitivity of earnings and the incremental value relevance of cash flows explains variation in the marginal pay‐sensitivity of cash flows. We document that while both value relevance and compensation weight on earnings decline from the subperiod of 1993 to 1997 to the subperiod of 1998 to 2003, both value relevance and compensation weight on cash flows increase from the earlier subperiod to the later subperiod. Overall, our results provide additional evidence that value relevance of a performance measure plays a significant role in its use for performance evaluation.     

Auditor quality effects on the relationship between accruals,cash flows and equity returns: a variance decomposition analysis

In this paper, we examine the relative importance of the cash flow and accruals components of earnings in explaining the variation in UK company equity returns, together with the extent to which these relationships vary by auditor quality. We use a multivariate time-series approach that can be reconciled to a log-linear theoretical valuation model and, unlike the standard linear regression of returns on earnings components, accommodates time-varying discount rates. Based on a decomposition of the variance of equity returns, cash flows and accruals, our results indicate that both cash flow news and accruals news are important drivers of UK equity returns, although cash flows are more influential than accruals. We also find that variation in both earnings components has a more significant effect on returns for clients of large auditors. Finally, our results provide mixed evidence on the question of whether the impact of auditor quality is highest for the accruals component of earnings.     

Is Financial Reporting Still Useful? Australian Evidence

There has been recent and growing criticism of the usefulness of financial reporting for investors, particularly the annual financial statements. In response, the IASB is pursuing several projects aimed at improving the relevance of financial information. To inform the IASB’s work, we investigate, using a mixed-method approach, the extent and nature of the use of annual financial statements by equity investors. We examine the relevance of financial reporting for equity valuation in Australia across time. We find that financial reporting (specifically, reported net income, shareholders’ equity, and operating cash flows) remains relevant for investment decisions. We further support this finding with evidence from field interviews that provide insight into how and why financial statements are used by equity investors. The field evidence also demonstrates that no one financial statement dominates in investor decision making. Given the increasing availability of more timely, forward-looking information from alternative sources, we examine the relevance of non-GAAP financial information and other non-financial information for investor decision making. We find that non-GAAP financial information (as proxied by EBIT and EBITDA) is more value relevant than statutory measures. We further find a broad range of non-financial information is utilized by investors in making investment decisions both as a ‘screen’ and for valuation purposes. Our findings inform regulators and other stakeholders as we provide evidence of the continuing relevance of financial statements and the complementary role of non-GAAP financial and other information. Our evidence provides a rebuttal to the recent criticism.     

The joint information role of analysts’ cash flow and earnings forecasts

We study whether the relative magnitudes of analysts’ cash flow and earnings forecasts convey information about the persistence and value relevance of reported earnings. We find that reported earnings are likely to be more (less) persistent and value relevant when analysts forecast relatively moderate (extreme) levels of operating cash flows, relative to earnings. We also find that the market’s response to a given earnings surprise is the strongest for moderate levels of cash flow forecasts relative to earnings. The joint information role of analysts’ cash flow and earnings forecasts persists even after controlling for the absolute accruals in the model.     

Earnings, Cash Flows and Security Returns Over Long Return Intervals: Analysis and UK Evidence

The aim of this paper is to provide a fuller understanding of the process linking security returns and accounting data by focusing on the effect of long return intervals on the association between security returns and earnings and cash flow variables. First, we develop a theoretical basis for empirical analysis of the relationship between security returns and cash flow data over long return intervals. Second, we carry out empirical analysis of both the information content of cash flow variables and the incremental information content of accounting earnings and cash flows using UK data over the period 1985–92 for annual, two year and four year return intervals. Our results provide strong evidence of the valuation relevance of cash flow information for the dataset examined.     

On the intertemporal value relevance of conventional financial accounting in Australia

This paper examines whether the relevance of conventional (earnings focused) accounting information for valuation has declined in Australia over a recent period of 28 years. Motivation is provided by the anecdotal concerns of financial analysts, accounting regulators, and a cluster of US centric academic research papers that conclude that the relevance of financial accounting (and earnings in particular) has declined over time. After controlling for nonlinearities and stock price inefficiencies, we find that the value relevance of core accounting earnings has not declined. A possible exception is found for small stocks. We also observe that net book values are relatively less important in Australia when compared to the USA. Our results are informative for investors who require feedback on valuation issues and the International Accounting Standards Board regulators in any further moves towards a balance sheet focus.     

Professionalism vs Commercialism: The Association Between Non-Audit Services (NAS) and Audit Independence

This paper examines the relative information content of earnings and cash flows for security returns using a methodology incorporating contextual factors which may affect earnings and cash flow response coefficients. For our UK dataset, we provide evidence that the earnings coefficient is related to earnings permanence, growth and firm size and that the cash flow coefficient may be related to growth. Although our results emphasise the value relevance of earnings, they also suggest that both contemporaneous and prior period cash flow are positively related to security returns and that market-to-book and market value of equity have predictive power for returns.     

会计盈余、现金流量的价值相关性实证研究基于沪深股市的实证证据

已有的研究结果说明会计盈余具有价值相关性。从盈余等于经营现金流量与应计利润之和这一新的视角切入，以实证的方法对沪深两地上市的A股公司进行三大样本检验。并通过建立股票报酬与应计利润和现金流量的回归方程，利用应计利润回归系数的显著性对会计盈余与现金流量的价值相关性做比较，结果表明，会计盈余的价值相关性要大于现金流量的价值相关性。     

The role of accruals and cash flows in explaining security returns: Evidence from New Zealand

This paper empirically examines the relative and incremental information content of earnings and cash flows and the role of firm-specific contextual factors in moderating information content in New Zealand. Accounting earnings are considered to be the premier information source for decision making and a substantial volume of literature, primarily in the United States, shows that earnings provide superior information to that of cash flows. However, significant reporting differences in New Zealand warrant and investigation of the role of earnings and cash flows to explain security returns. Results show that (a) earnings have higher explanatory power than cash flows, although the difference is not statistically significant, and (b) both earnings and cash flows have incremental information content for stock returns. Further analysis shows that the valuation role of earnings and cash flows is moderated by firm-specific factors.     

THE IMPACT OF THE QUALITY OF EARNINGS ON THE VALUATION RELEVANCE OF CASH FLOW DISCLOSURES

This study investigates whether the ‘quality of earnings’, defined as the relationship between profitability and cash generating ability, is a conditioning factor with regard to the valuation relevance of cash flow disclosures. The study is performed on a sample of 197 British firms employing data over a 23-year period. The results of the study support the contention that the valuation relevance of cash flow disclosures is conditional upon the ‘quality of earnings’, as previously defined. Specifically, the decomposition of unexpected earnings into its cash flow and accruals components provides incremental information content to earnings when the firm-specific time-series correlation between earnings and cash flows is low. Furthermore, the cash flow ‘surprise’ is valued more than the accruals ‘surprise’ when the firm-specific time-series correlation between earnings and cash flows is low.     

Has the value of cash increased over time?

We document a dramatic increase in the market valuation of cash holdings of US firms from 1988 to 2013. The value of one dollar of cash has increased by $0.019 per year during the period, indicating that shareholders place more value on cash in recent years. We also find that the increasing trend in cash value is driven mainly by increases in institutional shareholdings and accounting conservatism. We further decompose cash change into cash flows from operation (CFO) and cash flows from investing and financing activities, and find that CFO is a significant driver of the increasing trend in cash value.     

Dividends,research and development expenditures,and the value relevance of book value for UK loss-making firms

We extend prior research on the value relevance of accounting information for loss-making firms by allowing the coefficient of book value to vary across three distinct set of loss-making firm observations in our valuation model. Our key findings are, first, that book value is a less important determinant of equity value for either high R&D-intensive firms or dividend-paying firms, relative to firms with low R&D-intensity and zero dividends. Prior literature suggests that book value is a strong indicator of firm value for loss-making firms. This reasoning stems from book value's role as: (i) a proxy for the value of the possibility of abandoning or adapting the firms' net assets; and/or (ii) a proxy for expected future normal earnings. Our work suggests that this prior literature does not fully capture the valuation role of book value for loss-making firms. Second, we also find that dividends are value relevant, but generally only when the valuation role of book value is contextualised by allowing its coefficient to vary across high R&D-intensive firms, and dividend-paying, loss-making firms.     

The value relevance of cash flows, current accruals, and non-current accruals in the UK

Cash flow statements have a longstanding history as mandated financial statement disclosures, having replaced funds flow statements. The usefulness of such disclosures with respect to one of the main purposes of financial statements—providing information relevant to the assessment of future cash flows and their uncertainty, and the market value of firms—is still subject to debate. This study investigates whether various partitions of earnings involving combinations of a cash flow measure of performance and measures of current accruals and non-current accruals improve the ability to explain market values in the UK relative to using earnings alone. Using a valuation model-based methodology, and employing a UK sample of non-financial firms for the years 1993 to 2007, our results suggest strong support for the assertion that cash flows can have incremental value relevance relative to either earnings or funds flows. By implication, cash flows can have separate value relevance from total and, in particular, current accruals. There is slightly less consistent evidence that current and non-current accruals can have separate value relevance but, nonetheless, the results are still strongly in favour in this respect. Generally, the main source of increase in explanatory power for market values is the separate inclusion of our cash flow measure in the estimated regressions. As a consequence, we conclude that the statement of cash flows in the UK provides information useful to UK investors in valuing firms. Further, requiring a cash flow statement, as opposed to a funds flow statement, improves the information content of financial statements in the UK.