The interaction between earnings and cash flow : the consistency of signals and the effect of accruals volatility
This thesis examines whether the valuation relevance of earnings andlor cash flow is moderated by the consistency or the various combinations of signals provided by their unexpected surprises. This prediction is motivated by the expectation that consistent signaling of surprises in both measures will improve the perceived reliability of each. Another prediction is that the volatility of accruals determines the extent to which the consistency between earnings and cash flow surprises affects stock prices. The informativeness of the accounting measures of performance is evaluated by ascertaining whether they cause investors to change their evaluation of its fair value and adjust the share price accordingly. The existence of the predicted interaction effects is then examined by including interaction terms in the model specification as regressors. The tests are applied to a unique data set that addresses the issue of survivorship bias. Our results confirm that earnings and cash flow are not evaluated in isolation of each other in the market place. In particular, investors are seen to relate cash flow to earnings to assess the reliability of cash flow data. The extent to which this occurs, however, depends on the volatility of accruals. Finally, it should be emphasised that the more supportive results are provided after controlling for survivorship bias, which constrains the generalisability of prior research findings in this area.