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Article
Publication date: 3 June 2014

Wael Mostafa

Many studies examine the relative information content of earnings and cash flows from operations. Most studies find that earnings have higher information content than cash flows…

Abstract

Purpose

Many studies examine the relative information content of earnings and cash flows from operations. Most studies find that earnings have higher information content than cash flows. An interesting question that follows is whether these findings hold after controlling the extremity of earnings and cash flows. The purpose of this paper is to examine the relative information content of earnings and cash flows in the following four different cases: first, moderate earnings vs moderate cash flows, second, extreme earnings vs moderate cash flows, third, moderate earnings vs extreme cash flows, and fourth, extreme earnings vs extreme cash flows.

Design/methodology/approach

To assess the relative information content of earnings and cash flows for each of the four cases mentioned above, the authors compare the explanatory power for regression of returns on unexpected earnings relative to regression of returns on unexpected cash flows. Therefore, the author compares the adjusted R2 of the model with earnings variables and the model with cash flows variables using Vuong's test, that examines the statistical significance of the difference between adjusted R2s of the rival (non-nested) models, and interpret a statistically higher adjusted R2 as an indicator for higher relative information content.

Findings

The results show that: first, when both earnings and cash flows are moderate, earnings are more highly associated with stock market price changes than cash flows, second, when both earnings and cash flows are extreme, earnings also have greater relative information content than cash flows, third, when the extremity differs between earnings and cash flows, the moderate variable is superior to the other extreme variable in explaining security returns. These results suggest that earnings are definitely more value relevant than cash flows. However, only in cases when cash flows from operations are moderate and earnings are extreme, cash flows possess higher information content than earnings.

Practical implications

The explanatory power for stock returns will be higher for earnings or cash flows depending on which is more highly persistent. This result reverses the conventional finding of the superiority of earnings over cash flows in explaining security returns.

Originality/value

In contrast to previous studies, the authors control for the extremity of earnings and cash flows when evaluating the relative information content of earnings and cash flows from operations.

Details

Managerial Finance, vol. 40 no. 7
Type: Research Article
ISSN: 0307-4358

Keywords

Article
Publication date: 31 October 2008

Amal A. Said, Hassan R. HassabElnaby and Tanya S. Nowlin

The purpose of this paper is to examine the relative and incremental information content of a cash recovery‐based measure of performance, the estimated internal rate of return, vs…

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Abstract

Purpose

The purpose of this paper is to examine the relative and incremental information content of a cash recovery‐based measure of performance, the estimated internal rate of return, vs an earnings‐based measure of performance, return on assets, in explaining firms' economic performance.

Design/methodology/approach

The paper uses the cash recovery rate that is based on continuous time analysis and U‐shaped cash flows to derive the estimated internal rate of return and compare it to return on assets. A cross‐sectional sample was used over a short interval (year 1993 and year 2005) and a time‐series sample (1993‐2005) to empirically examine the relative and incremental information content of the competing measures. Tobin's q and stock returns are used as performance benchmarks.

Findings

The results of the empirical tests indicate that the estimated internal rate of return provides better relative and incremental information content over earnings‐based measures of performance. Specifically, the empirical evidence shows that the estimated internal rate of return is consistently positively related to Tobin's q and stock returns over all measurement intervals.

Research limitations/implications

These results imply that earnings‐based performance measures are less value relevant compared to cash recovery‐based measures. There are some limitations that may apply to this study. First, the systematic measurement error in estimating the cash recovery rate may not be independent of the measurement error in the estimated internal rate of return. Second, the performance benchmarks used in the study are not free from problems. Particularly, the return on assets is influenced by firms' rate of growth and the Tobin's q is not a perfect measure of business performance. Therefore, one avenue of future research is to assess the usefulness of financial accounting data for analysts forecast. Moreover, future research may also examine the role of institutional changes in financial reporting and its effect on the quality of earnings and economic performance.

Originality/value

This paper presents extended research on cash recovery‐based vs earnings‐based metrics as proxies for economic return using improved research designs, larger samples and new sensitivity analyses.

Details

Review of Accounting and Finance, vol. 7 no. 4
Type: Research Article
ISSN: 1475-7702

Keywords

Article
Publication date: 1 October 2008

P.D. Erasmus

This study implements inflation adjustments, as proposed by International Accounting Standard 15 (IAS15), to determine an inflation‐adjusted version of Economic Value Added (EVA)…

Abstract

This study implements inflation adjustments, as proposed by International Accounting Standard 15 (IAS15), to determine an inflation‐adjusted version of Economic Value Added (EVA). The relationships between the nominal (EVAnom) and inflation‐adjusted (EVAreal) versions of EVA, and market‐adjusted share returns are investigated, and compared with those of residual income, earnings and operating cash flow. Relative information content tests suggest that earnings have the strongest relationship with share returns, while the results of the incremental tests indicate that the EVAnom and EVAreal components do not provide statistically significant information content beyond that provided by residual income.

Details

Meditari Accountancy Research, vol. 16 no. 2
Type: Research Article
ISSN: 1022-2529

Keywords

Article
Publication date: 25 October 2011

Satish Kumar and A.K. Sharma

The main objective of this study is to examine the claim of economic value added (EVA) proponents about its superiority as a financial performance measure compared to five…

2713

Abstract

Purpose

The main objective of this study is to examine the claim of economic value added (EVA) proponents about its superiority as a financial performance measure compared to five traditional performance measures, i.e. net operating profit after tax (NOPAT), cash flow from operations (OCF), earnings per share (EPS), return on capital employed (ROCE) and return on equity (ROE) in Indian manufacturing sector, and simultaneously provide its empirical evidences. To achieve this, relative and incremental information content of various performance measures and their relationship with market value added (MVA) is tested and examined.

Design/methodology/approach

Principal component analysis (PCA) is one of the important multivariate methods utilized in business research for data reduction, latent variable modeling, multicollinearity resolution, etc. The present sample consists of 608 firm‐year observations from the Indian manufacturing sector for the period 2000‐2007. Firstly, principal component analysis (PCA) is employed to determine the important variables that explain market value. Secondly, alongside PCA, multiple regression models (OLS) are used to examine the relative and incremental information content of EVA and traditional performance measures.

Findings

These results about PCA reveal that variables like NOPAT, OCF, ROE, ROCE and EVA have maximum influence on the market value (MVA) of the sample companies, whereas EPS has a negative loading, so, EPS is discarded for further analysis. Further, the PCA loading matrix reveals that NOPAT, OCF, ROE and ROCE outscore EVA. The regression results regarding the relative information content test reveal that NOAPT and OCF outperform EVA in explaining the market value of Indian companies. The incremental information content test shows that EVA makes a marginal contribution to information content beyond NOPAT, OCF, ROCE and ROE. Overall, these empirical results about Indian companies do not support the Stern Stewart hypothesis that EVA is superior to traditional accounting‐based measures in association with market value of the firm.

Originality/value

The study concludes that along with financial variables, other non‐financial variables such as employees, product quality, etc., should be considered in order to capture the unexplained variation in the market value of Indian companies.

Details

Journal of Financial Reporting and Accounting, vol. 9 no. 2
Type: Research Article
ISSN: 1985-2517

Keywords

Article
Publication date: 27 September 2011

Satish Kumar and A.K. Sharma

The purpose of this paper is to examine the claim of economic value added (EVA) proponents about its superiority as a corporate financial performance measure, compared to…

1733

Abstract

Purpose

The purpose of this paper is to examine the claim of economic value added (EVA) proponents about its superiority as a corporate financial performance measure, compared to traditional performance measures in non‐financial Indian companies and provide empirical evidences.

Design/methodology/approach

The paper uses a sample of 873 firms‐year observations from the Indian market and applies pooled ordinary least square regression to test the relative and incremental information content of EVA and other accounting‐based measures in explaining the market value added.

Findings

The results about relative information content test reveal that NOAPT and OCF outperform EVA in explaining the market value of Indian companies. Incremental information content test shows that EVA makes a marginal contribution to information content beyond traditional performance measures such as NOPAT, OCF, EPS and RONW, etc. Overall the authors' results do not support the hypothesis that EVA is superior to traditional accounting‐based measures in association with market value of the firm.

Originality/value

The authors conclude that non‐financial variables such employees, product quality and community satisfaction should be considered in order to capture the unexplained variation in the market value of the firm.

Article
Publication date: 20 November 2023

Wael Mostafa and Rob Dixon

Recent studies on the securities market’s differential pricing of earnings components have shown that cash flow from operations is more highly valued than total accruals and that…

Abstract

Purpose

Recent studies on the securities market’s differential pricing of earnings components have shown that cash flow from operations is more highly valued than total accruals and that moderate cash flow from operations has higher valuation than extreme total accruals. An interesting question that follows is whether these findings hold regarding the differential valuations of cash flow and current accruals. This study aims to extend prior research by addressing this issue in two ways. First, the authors examine the incremental information content of cash flow from operations beyond working capital from operations. Second, the authors assess the effect of extreme working capital from operations on the incremental information content of cash flow from operations. This study aims to extend prior research by addressing this issue in two ways.

Design/methodology/approach

This study adopts market-based accounting research to test its hypotheses and to achieve its objectives. Specifically, this study uses statistical associations between accounting data and stock returns to examine the incremental information content (value relevance) of cash flow and working capital from operations and the effect of extreme working capital from operations on the incremental information content of cash flow.

Findings

The results show that cash flow from operations is not more highly valued than current accruals (both being valued equivalently). However, moderate cash flow from operations has higher valuation than extreme current accruals (each is valued differently). Overall, these research findings indicate that cash flow becomes more important for valuation as accruals get “extreme”.

Practical implications

As accruals are unlikely to persist to be permanent across the years, these results can be interpreted as indicating that cash flow and accruals information are used jointly by investors, with one being more important than the other depending on the relative “extremeness” of each. Therefore, both are of value to the investor and both should be reported.

Originality/value

The paper contributes to the UK research on determining the preferred level of disaggregation of earnings components, i.e. operating cash flow, current accruals and non-current accruals. This would help investors to improve their investment and credit decisions.

Article
Publication date: 17 June 2020

Harnesh Makhija and Pankaj Trivedi

The paper aims to find out the information content of performance measures from accounting and value-based measures that best explain the total shareholder return.

Abstract

Purpose

The paper aims to find out the information content of performance measures from accounting and value-based measures that best explain the total shareholder return.

Design/ methodology/ approach

To achieve this aim, static and dynamic panel data regression analysis is applied to the sample of 56 Indian companies taken from the Nifty Midcap 100 Index, between 2012 and 2019.

Findings

It is found that accounting-based measures have more relative information content in predicting total shareholder return as compared to value-based measures. Economic value added (EVA) and cash value added (CVA) do not add to the information content provided by accounting-based measures. A combination of accounting-based measures and value-added intellectual coefficient (VAIC) adds marginally to the information content provided by accounting-based measures in explaining the total shareholder return. Dynamic panel regression analysis shows that return on assets (ROA), return on capital employed (ROCE), return on equity (ROE) and EVA have a significant impact on total shareholder return.

Originality/value

In this study, along with EVA, other measures from value-based measures, i.e. CVA are empirically tested to explain the total shareholder return. Intellectual capital efficiency computed by VAIC is also empirically tested along with accounting-based measures, EVA, CVA and market value added (MVA). To bring robustness to findings, data are tested by using dynamic panel regression analysis.

Details

International Journal of Productivity and Performance Management, vol. 70 no. 5
Type: Research Article
ISSN: 1741-0401

Keywords

Article
Publication date: 1 March 2002

S.P. Bandyopadhyay, A.S. Hilton and G.D. Richardson

Explains that Canada is currently deciding whether to harmonize with US or international accounting standards and whether to allow Canadian SEC registrants to file their financial…

Abstract

Explains that Canada is currently deciding whether to harmonize with US or international accounting standards and whether to allow Canadian SEC registrants to file their financial statements using US standards, outlines previous research on the information content of US/Canadian differences and tests the relative and incremental information content of 156 interlisted firms 1996‐1998. Explains the methodology and presents the results, which suggest that there is little difference in the relative information content of the two sets of standards although each provides information incremental to the other. Concludes that investors will not be harmed either by harmonization or by allowing financial reporting under US standards.

Details

Managerial Finance, vol. 28 no. 3
Type: Research Article
ISSN: 0307-4358

Keywords

Article
Publication date: 4 March 2014

Cheng-Yi Chien, Tzu-Hsiang Liao and Hsiu-Chuan Lee

– This paper aims to examine the impact of a reduction in tick size on the information content of the order book by using data from the Taiwan Stock Exchange (TWSE).

Abstract

Purpose

This paper aims to examine the impact of a reduction in tick size on the information content of the order book by using data from the Taiwan Stock Exchange (TWSE).

Design/methodology/approach

To estimate the information content of the order book, the modified information share proposed by Hasbrouck and extended by Lien and Shrestha is used in this paper.

Findings

The empirical results show that the limit order book is informative. Furthermore, the results indicate that a reduction in tick size will decrease the information content of the order book and the decrease in the information content of the order book is positively related to the thinner order book.

Originality/value

This paper suggests that, in order to enhance the information content of the order book, the TWSE should disclose the full limit order book.

Details

Managerial Finance, vol. 40 no. 3
Type: Research Article
ISSN: 0307-4358

Keywords

Open Access
Article
Publication date: 29 September 2022

Jasvir S. Sura, Rajender Panchal and Anju Lather

The main aim of this paper is to examine the claim that economic value added (EVA) advocates its superiority over the traditional accounting-based financial performance measures…

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Abstract

Purpose

The main aim of this paper is to examine the claim that economic value added (EVA) advocates its superiority over the traditional accounting-based financial performance measures, i.e. profit after tax (PAT), earnings per share (EPS), return on assets (ROA), return on equity (ROE) and return on investment (ROI) in the Indian manufacturing sector and at the same time, give empirical facts. It also tests and examines the information content of various performance measures and their relationship with stock returns.

Design/methodology/approach

The paper uses the sample of 534 Indian manufacturing companies from the Bombay Stock Exchange (BSE) during the period 2000–2018. Multiple regression models are applied to examine the information content of EVA and traditional performance measures in explaining shareholders’ returns.

Findings

Relative information content tests revealed that traditional accounting-based measures such as EPS, ROE and ROA performed better than EVA in explaining the returns of Indian manufacturing companies. Incremental information content of EVA adds little contribution to information content above traditional performance measures. The claim of superiority of EVA over accounting-based measures in association with shareholder returns is proved invalid in Indian manufacturing companies.

Originality/value

This study concludes that EVA has no superiority over traditional accounting-based financial performance measures in explaining stock returns of Indian manufacturing companies. To achieve heftiness in outcomes, panel data are tested by using Breusch–Pagan–Godfrey (BPG) test for heteroskedasticity, Hausman’s test for fixed and random effect, variance inflation factor (VIF) test for multicollinearity and Durbin–Watson test for autocorrelation.

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