The operating cycle and the information content of earnings and cash flow

Abstract

Prior studies have found that earnings are relatively more informative than cash flows (e.g. Ali and Pope, 1993; Ali, 1994; Plenborg, 1996). Applying Danish data this study investigates whether the length of the operating cycle is a useful explanation for the superiority of earnings over cash flows in explaining the contemporaneous stock return. Using a capital market approach, the study finds that the explanatory power of earnings is stable, but the explanatory power of cash flows declines as the length of the operating cycle increases. This finding holds across various research designs and model specifications.