Australian evidence on analysts' cash flow forecasts: issuance,accuracy and usefulness

This study examines the factors affecting the issuance, accuracy and usefulness of analysts' cash flow forecasts (CFFs) in Australia. Given the economic importance of the mining industry in Australia, we find that analysts are likely to provide CFFs for mining firms with poor financial health and high default risk. In contrast, analysts' provision of CFFs increases with the degree of financial health for non‐mining firms. The determinants of the issuance and accuracy of analysts' CFFs also differ in pre‐ and post‐IFRS adoption periods. Our results add new evidence on the effect of IFRS adoption on analysts' cash flow forecasting behaviours.     

Impact of IFRS in New Zealand on Accounts and Earnings Quality

The impact of the adoption of International Financial Reporting Standards (IFRS) on the accounts and the quality of earnings of New Zealand firms is examined. Our analysis of IFRS adjustments for the last period under pre‐IFRS NZ Generally Accepted Accounting Principles (GAAP) reveals that total assets, total liabilities and net profit were significantly higher under IFRS than under pre‐IFRS GAAP. Profit and equity under IFRS were increased by adjustments for goodwill and other intangibles and investment property, and decreased by adjustments for employee benefits and share‐based payments. Using data for 2002–2009, we find that absolute discretionary accruals were significantly higher under IFRS than under pre‐IFRS NZ GAAP, suggesting lower earnings quality under IFRS than under pre‐IFRS NZ GAAP. However, we find no significant differences in signed discretionary accruals and the ability of earnings to predict one‐year‐ahead cash flows between pre‐IFRS NZ GAAP and IFRS. These results are consistent across alternative measures of accruals quality, sample selection and whether firms elected to adopt IFRS in 2005 rather than comply with them in 2007.     

Do earnings reported under IFRS tell us more about future earnings and cash flows?

We contribute to the debate about the relative benefits and costs of International Financial Reporting Standards (IFRS) adoption by examining whether earnings persistence and the association between current accounting earnings and future cash flows differ for firms reporting under IFRS versus firms reporting under United States Generally Accepted Accounting Principles (U.S. GAAP) and firms reporting under non-U.S. domestic accounting standards (DAS). Using samples comprised of 58,832 firm-year observations drawn from 33 countries from 2002 through 2008, we find that positive earnings reported under IFRS are no more or less persistent than earnings reported under U.S. GAAP but losses reported under IFRS are less persistent than losses reported under U.S. GAAP. Moreover, we find that earnings reported under IFRS are no more or less persistent and are no more or less associated with future cash flows than earnings reported under non-U.S. DAS. However, we find that earnings reported under U.S. GAAP are more closely associated with future cash flows than earnings reported under IFRS. This is important if a key role of reported earnings is to help investors form expectations about future cash flows. These results should be of interest to academics and standard-setters as they debate the merits of transitioning to IFRS, and to parties who use reported earnings to form expectations about future earnings and cash flows.     

Earnings Reported under IFRS Improve the Prediction of Future Cash Flows? Evidence from European Banks

This paper examines the relative costs and benefits of International Financial Reporting Standards (IFRS) adoption in the European Union by testing the ability of earnings computed under IFRS to predict future cash flows. The study considers the contribution of net income, comprehensive income and other comprehensive income to the usefulness of earnings to predict cash flows, and it compares IFRS with domestic Generally Accepted Accounting Principles (GAAP). Evidence from a sample of Continental European banks shows that IFRS improve the ability of net income to predict future cash flows. Comprehensive income, too, provides relevant information to predict future cash flows, although with a measurement error which is higher than that in net income for greater lags of time. In our interpretation, these findings are consistent with unrealised gains and losses recognised in other comprehensive income being more transitory and volatile in nature. Overall, our results are relevant to academics and standard setters debating the merits of IFRS adoption and to those who use financial statements and adopt reported earnings to form expectations about future cash flows.     

Do Macro-economic Crises Determine Accounting Value Relevance?

Abstract

We investigate whether the value relevance of earnings and book values in Turkey significantly changed across periods of financial uncertainty. Our enquiry differs from the mainstream literature that posits a unidirectional association determined by the ‘quality’ of individual firm accounts towards price. We find divergence in accounting value relevance components across the 1997–2012 period. Dominant value relevance shifts from earnings and negative interest rates in hyper-inflation, to the balance sheet after IFRS in 2005. On the other hand, the global financial crisis (GFC) is associated with diminished accounting value relevance for all variables. Policy issues are raised about value relevance consistency, the use of negative (low) interest rates as fiscal policies and the asymmetric application of market based valuations in emerging economies.     

Do Accruals Earnings Management Constraints and Intellectual Capital Efficiency Trigger Asymmetric Cost Behaviour? Evidence from Australia

This study examines whether accruals earnings management constraints and intellectual capital (IC) efficiency affect asymmetric cost behaviour by analysing data for the 1990 to 2016 period on firms listed on the Australian Securities Exchange. The analysis reveals that, on average, anti‐sticky cost behaviour occurs when firms have limited ability to engage in accrual earnings management to manipulate earnings in the current year. Further, IC efficiency – particularly human capital efficiency – increases the degree of cost stickiness. This study also finds that the degree of asymmetric cost behaviour is more pronounced in the post‐International Financial Reporting Standards (IFRS) period than in the pre‐IFRS period. The results suggest that the increased asymmetric cost behaviour in the post‐IFRS period derives from higher IC efficiency relative to the pre‐IFRS period. This study presents important implications for external stakeholders because they can consider the extent of earnings management constraints and the extent of firms’ IC efficiency as the determinants of asymmetric cost behaviour when assessing firms’ cost behaviour.     

Impact of the global financial crisis on Islamic and conventional stocks and bonds

This study explores the impact of the global financial crisis (GFC) on Islamic and conventional stock and bond indices in 11 Islamic and eight non‐Islamic countries. We find that there are benefits of Islamic stocks during the GFC, particularly during the early stage of the crisis because Islamic institutions are prohibited from holding sub‐prime mortgage securities and derivatives. The strongest benefits of Islamic stocks are in the UK and USA. We conclude that there are benefits of risk reduction and stability for Islamic stocks during a financial crisis, although not necessarily during a global recession.     

Changes in accrual properties and operating environment: Implications for cash flow predictability

This paper reconciles conflicting evidence in prior literature on the relative ability of earnings and cash flows in predicting future cash flows. Further, we investigate the implications of temporal shifts in accrual properties and operating environment for cash flow predictability. Three key insights emerge. First, cash flows consistently outperform earnings in predicting future cash flows. Second, accruals and its components, including those capturing non-articulating events, have incremental (albeit small) predictive ability over cash flows. Third, earnings’ ability to predict future cash flows has increased over the period 1989–2015, due to changes in operating environment rather than accrual properties.     

Cash flow disaggregation and the prediction of future earnings

We examine the incremental information content of the components of cash flows from operations (CFO). Specifically the research question examined in this paper is whether models incorporating components of CFO to predict future earnings provide lower prediction errors than models incorporating simply net CFO. We use Australian data in this setting as all companies were required to provide information using the direct method during the sample period. We find that the cash flow components model is superior to an aggregate cash flow model in terms of explanatory power and predictive ability for future earnings; and that disclosure of non‐core (core) cash flows components is (not) useful in both respects. Our results are of relevance to investors and analysts in estimating earnings forecasts, managers of firms in regulators’ domains where choice is provided with respect to the disclosure of CFO and also to regulators’ deliberations on disclosure requirements and recommendations.     

Prediction of Operating Cash Flows: Further Evidence from Australia

This paper examines empirically the relative abilities of current operating cash flows (hereafter OCF) and earnings in predicting future operating cash flows in Australia. It extends prior Australian research on cash flow prediction ( Percy and Stokes 1992 ; Clinch, Sidhu and Sing 2002 ; Farshadfar, Ng and Brimble 2009 ) by examining future cash flow predictions for one‐, two‐ and three‐year‐ahead forecast horizons; incorporating additional contextual variables likely to affect the predictive association between current cash flows or earnings and future cash flows; and comparing cross‐sectional versus time series‐based prediction models to ascertain the relative superiority of one approach over the other. Regression results reveal that the cash flow‐based models are more accurate in predicting future operating cash flows than earnings‐based models. This result, however, is moderated by firm‐specific contextual factors like firm size, negative versus positive cash flow pattern, cash flow variability and firm operating cycle. Finally, a comparison between cross‐sectional and time series approaches reveals that the cross‐sectional model outperforms the time series model for both the operating cash flows and earnings models in most of the forecast years.     

Further evidence of the relationship between accruals and future cash flows

Focusing only on operating accruals in accrual‐based studies results in a loss of information and noisy measures of both accrual and cash flow components of earnings. Thus, we examine the relative importance of working capital accruals, non‐current operating accruals, and financing accruals with regard to future cash flows from operations (CFO). Using Australian data, we provide evidence that both working capital and non‐current operating accruals are important for explaining future CFO but that the contribution of financing accruals is not significant. Moreover, the asset component of accruals plays a more important role in explaining future CFO than the liability component.     

Has the IASB Been Successful in Making Accounting Earnings More Useful for Prediction and Valuation? UK Evidence

When producing International Financial Reporting Standards (IFRS), one of the main goals of the International Accounting Standards Board (IASB) was to create a set of standards which were more useful to investors as a predictive tool. We assess the success of the IASB in achieving this goal by investigating the effects of the introduction of IFRS on the relative information content of reported earnings and forecasted earnings under UK generally accepted accounting practices (GAAP) and IFRS. Results indicate that the value relevance of forecasted earnings is significantly lower under IFRS while the value relevance of reported earnings is significantly larger. These findings suggest that IFRS substitutes price‐relevant information previously provided to the market in the form of analyst forecasts with information encoded by companies in their reported earnings. This implies that the IASB was indeed successful in its stated goal and points towards IFRS forecasts being more accurate and less dispersed than UK GAAP forecasts. This, in turn, implies that analysts are able to provide more informative forecasts under IFRS than under pre‐IFRS regimes and that the aforementioned substitution effect is not a consequence of any decrease in the quality of forecasts under the new regime.     

The determinants of equity agency conflicts between managers and shareholders: Evidence from Australia

We analyse the determinants of equity agency costs for the top 500 Australian listed firms. Data are collected over four one-year periods (2004, 2005, 2010 and 2011) and analysed using both pooled OLS regression and two stage least squares regression within a random effects panel data model. Analysis covers the full four-year period, the pre global financial crisis (GFC) sub-period (2004 and 2005) and the post GFC sub-period (2010 and 2011). Shareholding, board characteristics and debt financing are found to have an impact on agency costs though there is evidence of some change in these relations with the onset of the GFC, particularly with respect to the impact of insider ownership and board size.     

Has Adoption of IFRS Increased Non–North American Institutional Investment in the Canadian Stock Markets?

We investigate whether non–North American (non‐NA) institutional investment in firms listed on the Canadian stock markets increased between the pre‐ and post‐IFRS adoption periods relative to such investment in firms listed on the U.S. stock markets. Prior to IFRS adoption, Canada had high‐quality financial reporting standards that were similar to the U.S. standards. As consequences of IFRS adoption, Canadian financial statements became more comparable with European and other IFRS country financial statements and less comparable with neighboring U.S. financial statements. Thus, a question of interest is whether the enhanced comparability with non‐NA companies was beneficial in terms of attracting non‐NA investment to Canadian companies versus U.S. companies. We find that there was no significant change in non‐NA institutional investment in Canadian firms relative to U.S. firms for the very largest (fifth quintile) and for smaller (first, second, and third quintiles) Canadian companies. However, intermediate‐sized Canadian companies in the fourth size quintile lost non‐NA institutional investment relative to their U.S. peer companies, suggesting that non‐NA investors cared more about comparability with U.S. peer companies than non‐NA peer companies for companies in this size quintile.     

Forecasts in IPO Prospectuses: The Effect of Corporate Governance on Earnings Management

Prior research suggests that managers may use earnings management to meet voluntary earnings forecasts. We document the extent of earnings management undertaken within Canadian Initial Public Offerings (IPOs) and study the extent to which companies with better corporate governance systems are less likely to use earnings management to achieve their earnings forecasts. In addition, we test other factors that differentiate forecasting from non‐forecasting firms, and assess the impact of forecasting and corporate governance on future cash flow prediction. We find that firms with better corporate governance are less likely to include a voluntary earnings forecast in their IPO prospectus. In addition, we find that while IPO firms use accruals management to meet forecasts; the informativeness of the discretionary accruals depends on whether or not the firm would have missed its forecast without the use of discretionary accruals.     

Communicating the Impact of the Global Financial Crisis in Annual Reports: A Study of Australian NGOs

This paper analyses the extent and nature of communication by Australian non‐governmental organisations (NGOs) about the impact of the global financial crisis (GFC). NGOs need to balance their communications about financial need against news that could potentially reflect negatively on stakeholders’ impressions of their worthiness to receive funding. Recognising this, we content analyse the annual report narratives of 10 Australian NGOs for information about the impact of the GFC and their use of impression management (IM) techniques. All NGOs in the study experienced some financial impact from the GFC, with nine referring to it in their annual report narratives. However, the information was very limited, indicating a missed opportunity to communicate meaningfully with stakeholders. Further, of the nine NGOs providing disclosures about the GFC's impact, eight used at least one IM technique, indicating a lack of transparency that has potentially negative implications for trust‐building with their stakeholders. This study focuses on a limited number of NGOs, but further research could broaden this approach to examine organisations in the broader not‐for‐profit (NFP) sector, other modes of communication or communication patterns at other times of crisis, and currently, in an era of austerity.     

The association between earnings quality and the cost of equity capital: Evidence from the UK

Empirical evidence that examines the association between earnings quality and the cost of equity supports theoretical work that information risk is a non-diversifiable risk factor. However, the main body of evidence, centred on Francis et al.'s (2004) seminal work, focuses on earnings quality measures that are based on US GAAP. This study extends the analysis of Francis et al. (2004) for a sample of UK listed firms during the period 2005 to 2011. This setting and time period enables us to examine the effect of IFRS based earnings on the pricing of earnings quality and how this relation is influenced by a period of severe macro-economic turbulence as in the case of the recent global financial crisis. We find a significant negative association between each accounting-based earnings quality proxy considered separately and the cost of equity. Our results also indicate that during the financial crisis the relationship between earnings quality and cost of equity becomes more prominent than in the pre-crisis period. Our results also document that investors place more importance on the innate component of accruals quality than on the discretionary component. Our results should be of interest to US standard setters who are considering adopting or converging to IFRS.     

Does market discipline impact bank charter value? The case for Australia and Canada

This study analyses the relation between market discipline and bank charter value using a panel data set of publicly listed domestic banks in Australia and Canada over the period of 1995–2011, with a focus on the 2007–2008 global financial crisis (GFC). Overall, the results show a positive relation between market discipline and bank charter value, but this relation is weaker in the post‐GFC period. Our findings reveal that in the presence of market discipline, bank capital, contingent liabilities and non‐interest income are important sources of charter value. These findings have important policy implications related to bank stability. The results are robust to several model specifications.     

The effects of harmonization and convergence with IFRS on the timeliness of earnings reported under Chinese GAAP

This study examines the effects of a series of harmonization and convergence with IFRS on the timeliness of recognition of earnings in emerging Chinese markets. We find that earnings reported under Chinese GAAP have a lower earnings response coefficient, but a higher future earnings response coefficient, than earnings reported under IFRS before Chinese GAAP converged with IFRS in 2007. This indicates that earnings reported under Chinese GAAP are generally less timely than earnings reported under IFRS before convergence. We also find that the future earnings response coefficient of earnings reported under Chinese GAAP continues to increase, indicating that the timeliness of recognition of earnings reported under Chinese GAAP worsened after a series of harmonization and convergence with IFRS in China. Taken together, this study provides evidence indicating that harmonizing and converging national accounting standards with IFRS in emerging capital markets may not necessarily increase accounting quality.     

The Economic Effects of IFRS Goodwill Reporting

The promotion of the international harmonisation of goodwill accounting has led to the approval of SFAS 141 and 142 and IFRS 3, IAS 36 and IAS 38. The aim was to improve the quality and comparability of financial statements through these standards by eliminating the pooling of interests method and substituting the application of amortisation with an annual impairment test. However, recent decisions by regulating bodies such as the FASB, the IASB and the European Parliament have compromised this harmonisation. Currently, steps are being taken to reintroduce systematic amortisation in conjunction with the impairment test. In this dual normative scenario, where two accounting methods coexist (impairment test or amortisation), we analyse the economic consequences of the application of one method over the other in the information transmitted by the firms listed in the Spanish securities market. The contrast of two periods, pre‐IFRS (1998 to 2004) and post‐IFRS (2005 to 2011), reveals that the application of either of these methods affects financial statements and the usefulness of the information. Therefore, the possibility of opting for one or the other could distort the quality and comparability of the information transmitted by firms and the accurate assessment of future cash flows.