Expansión de la Orden

Historical cash flows and earnings provide useful information to help forecast future cash flows and earnings, when evaluating both future performance and current firm value. Consequently, a number of studies have examined the association between market returns and historical cash flows and earnings. Ball and Brown (1968) produced one of the first seminal papers in this field, empirically examining the association between accounting numbers in the form of annual net income and company stock returns. Their findings emphasised the value relevance of historical accounting information, and demonstrated a strong link between accounting earnings and stock price movements. By approximating cash flows as equivalent to operating income, Ball and Brown (1968) further found that net income was superior to their cash flow proxy when predicting the sign of abnormal stock returns. Extending the work of Ball and Brown (1968), Beaver and Dukes (1972) examined the information content of different measures of net income. Once again, changes in net income had the highest association with abnormal stock returns, as compared with changes in their cash flow proxy calculated as net income before depreciation, amortisation and deferred taxation.

3.2.2.1 Information Content Studies and Disaggregating Total Earnings

Subsequent research in this area further developed these initial studies by investigating the incremental information provided by income and cash flow variables when explaining stock returns. Two of the first such papers were the studies by Patell and Kaplan (1977) and Beaveret al. (1982). Defining cash flows as working capital, Patell and Kaplan (1977) found no evidence that percentage changes in cash flows provided incremental information to earnings when explaining stock returns. Beaveret al.(1982), however, defined cash flows as net income before depreciation and amortisation, and found weak evidence that percentage changes in cash flows did provide incremental information to earnings when explaining annual stock returns. A significant limitation of these initial papers, however, concerns their definitions for “cash flows”. These variables were highly correlated with earnings and, when explaining stock returns, were therefore unlikely to provide incremental information to earnings (Christieet al., 1984).

Following a similar progression to the cash flow prediction literature, capital market studies also disaggregated total earnings to investigate the information content of these components when explaining stock returns. Rayburn (1986), Wilson (1986), Wilson (1987), Bowen et al. (1987), and Bernard and Stober (1989) were some of the first studies to examine the effect of disaggregating earnings into operating cash flows and accruals on traditional abnormal stock returns models.

Defining cash flows as earnings before depreciation, amortisation and working capital movements, Rayburn (1986) found a significant association between abnormal stock returns, total cash flows and total accruals. While this study did not specifically compare the information content of cash flows and accruals with total earnings, Wilson (1986), Wilson (1987), and Bowenet al.(1987) addressed this in their papers. By using

daily stock returns, Wilson (1986) and Wilson (1987) compared the market reaction between the earnings announcement date and annual report release date. This allowed them to measure the impact of any incremental information released from reporting the disaggregated earnings components of accruals and operating cash flows in the latter report. Their findings show that accruals and operating cash flow components provided significantly more information than total earnings alone.

Moreover, Bowen et al. (1987), reverting back to an annual event window, found further evidence that unexpected operating cash flows provided incremental information content to explain abnormal stock returns beyond aggregate unexpected earnings. However, Bernard and Stober (1989) failed to find any significant association between unexpected cash flows and abnormal stock returns when extending Wilson’s (1987) model over a greater time period, implying that Wilson’s (1987) results may have been sample specific.

Dechow (1994) further extended the literature by examining the association of realised, rather than unexpected or abnormal, stock returns with quarterly and annual earnings and operating cash flows. Compared with prior research, which focussed on the relative information content of operating cash flows, earnings and accruals, Dechow (1994) set out to establish which variable provided the single best measure of firm performance. Given that the sample ended just after the introduction of SFAS No. 95, cash flows were estimated as operating income before depreciation less interest, taxes, and non-cash changes in working capital. Results from the cross-sectional regressions and Vuong (1989) tests show historical earnings to be the superior measure of firm performance. Providing further evidence of the high association of stock returns with earnings, Sloan (1996) argued that investors “fixated” on earnings when assessing firm

value, effectively ignoring the information found in the components of total earnings. Once total earnings were disaggregated into accruals and cash flows, he found that firms with high/(low) levels of accruals, relative to cash flows in historical earnings, experienced significantly negative/(positive) future abnormal stock returns. Disaggregating earnings clearly provided incremental information beyond that available in total earnings.

3.2.2.2 Disaggregating Operating Cash Flow into the Direct Method Components Most empirical research examining the capital market effects of the release of earnings and cash flow information investigated the information content of aggregate earnings, cash flows and accruals, rather than their disaggregated components. Livnat and Zarowin (1990), however, presented the first paper which tested the differential explanatory power of estimated direct cash flow components when explaining market returns. Their initial findings revealed statistically significant associations between cumulative abnormal stock returns and the unexpected cash collections from customers, payments to suppliers and employees, interest payments and other unexpected operating cash flows. Moreover, analysis of variance tests showed that direct cash flow components provide incremental information beyond aggregate operating cash flows when explaining cumulative abnormal stock returns.

Besides Livnat and Zarowin (1990), who estimated their direct cash flow components, no prior studies had examined whether direct cash flow components provided incremental information to aggregate operating cash flows when explaining capital market returns. Addressing this question would provide standard setters with useful evidence for the debate of whether or not to mandate the direct method of cash flow reporting. Clinch et al. (2002), therefore, extended Livnat and Zarowin’s (1990)

study by examining a large sample of listed Australian firms from 1992-1997, where they could use actual, rather than estimated direct cash flows.

Clinch et al. (2002) reported a significantly strong positive association between annual stock returns and the variables for cash collections from customers and cash paid to suppliers and employees. Chi-square tests of coefficient equality, however, revealed that while the disaggregated accruals provided incremental information for all firms, disaggregating cash flows only provided more information for mining firms. For industrial firms, disaggregating cash flows did not provide any further information when explaining stock returns. However, when controlling for the predictive power of the cash flow components, they found that when direct cash flow components provided incremental predictive power, they also provided further information to explain stock returns. Finally, following Livnat and Zarowin (1990), they estimated direct cash flow components. When comparing the actual and estimated direct cash flows components across all firms, they found that as the difference between the two increased, the incremental information provided by the actual direct cash flow components also increased. Direct cash flow statements, therefore, clearly provided value relevant information, and more so when more difficult to accurately estimate.

More recently, for a sample of U.S. firms, Orpurt and Zang (2009), in addition to establishing the usefulness of direct cash flows in forecasting future cash flows and earnings, examined the capital market effects on firms reporting direct cash flows. Using dummy variables, they investigated whether stock prices reflected more future earnings information for firms reporting direct cash flows compared with those using the indirect method. For firms using the direct method, they demonstrated a strong correlation between future earnings and current stock returns, as well as between future

operating cash flows and current stock returns. Investors, therefore, could more accurately forecast earnings for firms reporting direct cash flows, resulting in stock prices that better reflected future performance expectations, compared with firms reporting indirect cash flows.