The Relationship between Earnings,Funds Flows and Cash Flows: Evidence for the UK

Recent UK information content studies have provided evidence of a significant relationship between earnings and share prices, as in the US, but have also identified an apparent lack of information content for operating cash flow, which is in marked contrast to findings from US research. This paper provides direct evidence on the relationship between earnings, funds flows and cash flows in the UK during the period 1965–84, using tests of association and predictive tests based on a research methodology applied by Bowen, Burgstahler and Daley (1986) to US data. The results provide UK evidence on the contemporaneous and predictive relationships between measures of earnings, funds flows and cash flows which are generally consistent with the US findings of Bowen et al. and which do not support the view that earnings in the UK are superior to cash flows as predictors of future cash flows.     

Earnings Conservatism and Value Relevance Across the Business Cycle

Abstract:  Prior research has demonstrated higher value relevance of current earnings during economic expansions relative to contractions. We largely attribute such a result to expected growth prospects being captured in the current earnings coefficient when a direct proxy for expected future earnings is omitted from the returns-earnings model. We demonstrate that the conservatism and value relevance of current earnings is actually higher during economic contractions when including a proxy for future earnings expectations. We further demonstrate that the value-relevance of expected future earnings is higher during expansions, when the association between historical accounting information and future growth opportunities likely weakens.     

Stable Laws and the Present Value of Fixed Cash Flows

Abstract

In this paper, the authors consider the present value of a series of fixed cash flows under stochastic interest rates. To model these interest rates, they don’t use the common lognormal model, but stable laws, which better fit in with reality. Their main intention is to derive a result for the distribution function of such a present value. However, due to the dependencies between successive discounted payments, the calculation of an exact analytical distribution is impossible. Therefore, use is made of the methodology of comonotonic random variables and the convex ordering of risks, introduced by the same authors in some previous papers.

The present paper starts with a brief overview of properties and features of stable laws, and of the possible application of the concept of convex ordering to sums of risks, which is also the situation for a present value of future payments. Afterwards, the authors show how, for the present value under investigation, an approximation in the form of a convex upper bound can be derived. This upper bound has an easier structure than the original present value, and they derive elegant calculation formulas for the distribution of this bound. Finally, they provide some numerical examples that illustrate the precision of the approximation. Due to the design of the present value and the construction of the upper bound, these illustrations show great promise concerning the accuracy of the approximation.     

The Incremental Information Content of Earnings and Cash Flows from Operations Affected by Their Extremity

Previous returns studies have shown that extreme earnings and extreme cash flows from operations are less informative than moderate (i.e., less extreme) earnings and moderate cash flows. Studies also report that cash flows supplement to earnings in firm valuation by showing a higher association of cash flows with returns when earnings are extreme than when earnings are moderate. We propose that this supplementary role of cash flows is affected by cash flows extremity. Using data from the US capital markets, we find that the supplementary role of cash flows exists only when cash flows are not extreme. We also investigate the supplementary role of earnings to cash flows and search for a higher association of earnings with returns when cash flows are extreme than when cash flows are moderate. Similar to results on cash flows, our findings show that the supplementary role of earnings exists only when earnings are not extreme. Our results imply that investors and researchers should consider both earnings and cash flows extremity when assessing the information content of these variables.     

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.     

Earnings Quality Effect on Corporate Excess Cash Holdings and Their Marginal Value

By using panel data from Korea’s listed firms, we find that firms with poor earnings quality are more likely to accumulate excess cash holdings, perhaps in an attempt to buffer themselves from information asymmetry problems. We also find that firms with poor earnings quality are more likely to discount the marginal value of their excess cash holdings because their shareholders appear to question the reason for such cash policy changes from the agency theory perspective. Overall, our results suggest that information asymmetry and agency problems are likely to co-exist in firms with poor earnings quality.     

证券投资收益的价值相关性与盈余管理研究

随着证券市场的发展,证券投资收益成为上市公司一项重要的非经常性损益。本文检验了2007年新会计准则下上市公司证券投资收益的价值相关性与盈余管理现象,研究结果表明:(1)我国证券市场能够区分营业利润与证券投资收益,并根据它们的重要性而赋予不同的估值;(2)证券投资收益具有价值相关性,但不具有及时性;(3)上市公司通过出售时机的选择对已实现证券投资收益进行了盈余管理;(4)证券投资采用公允价值变动确认损益的方式既提高了会计信息的相关性,又避免了盈余管理,是一种更好的证券投资收益确认模式。基于上述研究结果,建议交易性金融资产和可供出售金融资产的公允价值变动均确认为损益,并对其进行及时、透明的表外信息披露。     

The Ability of Earnings to Predict Future Operating Cash Flows Has Been Increasing—Not Decreasing

We investigate the relationship between earnings and one‐year‐ahead operating cash flows from 1973 to 2000. Although the extant research indicates a weakening relationship between contemporaneous earnings and stock prices over time, we find that the relationship between current earnings and future operating cash flows has increased over time. This result holds for numerous divisions of our sample. Out‐of‐sample predictions of operating cash flows generally show increasing forecast accuracy over time. Increasing accounting conservatism appears to play a role in this phenomenon.     

亏损上市公司会计盈余价值相关性实证研究

会计盈余具备价值相关性的根本原因在于其预测能力,但对于亏损公司来说,为负值的会计盈余对未来会计盈余的预测能力明显是非常弱的,因此亏损公司会计盈余价值相关性与盈利公司有着很大的差异。本文对1998至2003年度的5705个研究样本中亏损公司会计盈余价值相关性的特性进行了实证分析,发现亏损公司会计盈余价值相关性要明显弱于盈利公司,同时也发现净资产变量的价值相关性同样偏弱。而决定亏损公司股票价格的主要因素则在于亏损公司发生卖壳行为的可能性。     

Corporate Data and Future Cash Flows

Abstract:   This article examines the ability of current accounting data to explain future cash flows for UK firms, as disclosed under FRS1 (1991). Rather than examining price data — from which cash flow implications have to be inferred — we follow the more direct approach used in several recent US studies, in which actual future cash flow data are examined. Specifically, our methodology is a development of the OLS regression framework employed by Barth et al. (2001) . We provide a replication of their main OLS analysis, and then extend this to deal with fixed effects and time trends in the levels of cash flow data. Our study finds that the disaggregation of earnings into cash flows and accruals, generates superior explanatory power with regard to future cash flows.     

Idiosyncratic Cash Flows and Systematic Risk

We show that unpriced cash flow shocks contain information about future priced risk. A positive idiosyncratic shock decreases the sensitivity of firm value to priced risk factors and simultaneously increases firm size and idiosyncratic risk. A simple model can therefore explain book‐to‐market and size anomalies, as well as the negative relation between idiosyncratic volatility and stock returns. Empirically, we find that anomalies are more pronounced for firms with high idiosyncratic cash flow volatility. More generally, our results imply that any economic variable correlated with the history of idiosyncratic shocks can help to explain expected stock returns.     

Do Stock Prices of Property Casualty Insurers Fully Reflect Information about Earnings,Accruals, Cash Flows,and Development?

This paper examines whether the stock prices of property and casualty (P&C) insurers fully reflect information contained in earnings, cash flows and accruals, and one particular accrual—development of loss reserves. The reserve for policy losses is a major accrual for P&C firms, requires substantial judgment and is the subject of unique disclosures that reveal the ex post error in management estimates. We find that investors underestimate the persistence of cash flows and overestimate the persistence of accruals for P&C insurers, but our evidence suggests the market does not underestimate the persistence of the development accrual.     

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.     

The Persistence and Pricing of the Cash Component of Earnings

Prior research shows that the cash component of earnings is more persistent than the accrual component. We decompose the cash component into: (1) the change in the cash balance, (2) issuances/distributions to debt, and (3) issuances/distributions to equity. We find that the higher persistence of the cash component is entirely due to the subcomponent related to equity. The other subcomponents have persistence levels almost identical to accruals. We investigate whether investors understand the implications of the differential persistence of the three subcomponents. Our results suggest that investors correctly price debt and equity issuances/distributions but misprice the change in the cash balance in a similar manner to accruals. Our tests enable us to empirically distinguish the “accrual” and “external financing” anomalies with results implying that the accrual anomaly subsumes the external financing anomaly. Our results also suggest that naive fixation on earnings is unlikely to be a complete explanation for the accrual anomaly. Our findings are more consistent with investors misunderstanding diminishing returns to new investments.     

Feedback from Stock Prices to Cash Flows

Feedback from financial market prices to cash flows arises when a firm's nonfinancial stakeholders, for example, its customers, employees, and suppliers, make decisions that are contingent on the information revealed by the price. Complementarities across stakeholders result in cascades, wherein relatively small stock price moves trigger substantial changes in asset values. This paper analyzes the relation between such feedback effects and parameters such as the information cost, the volatility of existing projects, the risk aversion of liquidity suppliers, and the precision of managerial information.     

Marketable Incentive Contracts and Capital Structure Relevance

This article investigates the claim that debt finance can increase firm value by curtailing managers' access to “free cash flow.” We first show that incentive contracts that tie the managers' pay to stockholder wealth are often a superior solution to the free cash flow problem. We then consider the possibility that the manager can trade on secondary capital markets. Liquid secondary markets are shown to undermine management incentive schemes and, in many cases, to restore the value of debt finance in controlling the free cash flow problem.