Abstract
A company’s sustainability is generally determined by whether it is able to create a positive long-term cash flow. This paper investigates whether the predictive ability of cash flows and earnings in forecasting future cash flows differs depending on the foreign investors’ ownership. Based on firms listed in the Korea Stock Exchange market from 2000 to 2017, we find that earnings and cash flow components of financial statements enhance the predictability of future cash flow in the Korean stock market. Conversely, foreign investors showed a tendency to decide on investments based on operating cash flow instead of earnings when predicting future cash flow. These findings indicate that reliability towards earnings may fall since foreign investors’ concerns are on the prospects of earnings management. These results were strengthened by the addition of several more analyses including cluster analyses, consideration of information asymmetry and the chaebol governance.
Highlights
Cash flow is paramount to the growth and sustainability of a business
This study finds that the effect of foreign investors’ preference for operating cash flow to the prediction of future cash flow is more significant in chaebol governance mechanism and it is more pronounced in environments where monitoring is unobstructed by information asymmetry
Where CFO = operating cash flow, it is defined as net cash flow from operating activities obtained from the cash flow statement adjusted for extraordinary items and discontinued operations; E = earnings before extraordinary items; foreign ownership variable (FOR) = percentage of outstanding common shares held by foreign investors; We deflate all variables by the average of total assets between the beginning and the end of the fiscal year
Summary
Cash flow is paramount to the growth and sustainability of a business. Though impressive revenues give the appearance of financial health, they can be misleading. According to the FASB, the main purpose of financial statements is to provide investors, creditors and anyone otherwise interested in the financial health of a particular company with information with which they can assess the amount and timing of future cash flow, which is most accurately predicted by earnings (FASB, 1978) The basis of this claim may lie in the theory that accrual-based accounting of earnings mitigates matching and timing issues inherent in cash-based accounting [7]. Another significant finding was that foreign investors preferred operating cash flow than accounting earnings of financial statements when making decisions on investment This indicates the importance of exploring the tendency and investing behaviors of foreign investors in view of future cash flow when conducting research connected with foreign investors. This paper is organized in five sections—Section 2 explains the theoretical basis of the study and proposes the hypotheses, Section 3 describes the design of the research and the sample selection process, Section 4 presents the empirical results and Section 5 offers the conclusions
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