Earnings Permanence and the Incremental Information Content of Cash Flows from Operations

Abstract

This paper investigates whether the incremental information content of cash flows from operations increases when earnings are transitory. We suggest that when the valuation implications of earnings are limited by the presence of transitory items, cash flows from operations disclosures may play a larger role as an additional value signal. We measure transitory items using earnings change scaled by beginning-of-period price (Ali [1994]) and the earnings-to-price ratio (Ou and Penman [1989] and Ali and Zarowin [1992]). Our analysis suggests that the incremental information content of accounting earnings decreases, and the incremental information content of cash flows from operations increases, with a decrease in the permanence of earnings.