Ability Of Earnings Research Articles

Fair Value Accounting and the Predictive Ability of Earnings: Evidence from the Banking Industry

This paper examines whether fair value adjustments included in other comprehensive income (OCI) can predict future performance in banks. We also examine whether the reliability of these fair value estimates affects their predictive value. Using a sample of bank holding companies, we find that fair value adjustments included in OCI can predict bank earnings both one and two years ahead. However, not all fair value related unrealized gains and losses included in OCI have similar implications for future performance. While unrealized gains and losses on available-for-sale securities are positively associated with future earnings, unrealized gains and losses on derivative contracts classified as cash flow hedges are negatively associated with future earnings. We also find that the predictive value of fair value estimates is enhanced when fair values are measured more reliably. Finally, we show that fair value adjustments recorded in OCI during the 2007-2009 financial crisis were predictive of future profitability, contradicting the criticism that fair value accounting forced banks to record excessive downward adjustments. Overall, our findings support the view of the Financial Accounting Standards Board and International Accounting Standards Board that use of fair value estimates in financial reporting meets their objective of providing decision-useful information about future firm performance.

Bank Regulatory Certification and Camel Framework-Related Accounting Signals in the Debt Market

This study investigates whether and to what extent bond investors in the financial institution sector free-ride on regulatory certification in non-financial crisis periods, and whether they use accounting signals in their decision-making process only during economic downturns. The recent bank crisis provides a perfect setting to test whether financial institutions’ financial accounting indicators related to the CAMEL framework of the U.S. Federal Bank Regulatory Agencies — capital adequacy, asset quality, earnings ability, and liquidity — enter at all into the decision-making process of investors holding a portfolio of debt instruments in financial institutions. Applying a perfect foresight portfolio investment strategy (Abarbanell and Bushee, 1998), I find evidence that cumulative monthly bond returns are associated with changes in ‘earning power’ and changes in credit ratings only when financial markets are illiquid and not transparent. This is potentially attributable to diverging interests of bank regulators and institutional bond investors during bank crisis periods, with debt holders conceivably relying to a lesser extent on regulatory agencies’ private information and certification. Moreover, I provide insight in terms of bond prices that have not fully anticipated accounting signals during periods of financial distress and uncertainty. To draw causal inferences, I also conduct an event study utilizing short-term windows centered on the U.S. Securities and Exchange Commission (SEC) EDGAR 10-K filing announcement dates and preliminary earnings announcement dates, and report the value relevance of financial indicators related to changes in ‘earning power’, liquidity, and capital adequacy for bond holders during the recent financial crisis period.

Equalizing Outcomes vs. Equalizing Opportunities: Optimal Taxation When Children'’s Abilities Depend on Parents' ’Resources

Empirical research suggests that parents' economic resources affect their children's future earnings abilities. Optimal tax policy therefore treats future ability distributions as endogenous to current taxes. We model this endogeneity, calibrate the model to match estimates of the intergenerational transmission of earnings ability in the United States, and use the model to simulate such an optimal policy numerically. The optimal policy in this context is more redistributive toward low-income parents than existing U.S. tax policy. It also increases the probability that low-income children move up the economic ladder, generating a present-value welfare gain of one and three-quarters percent of consumption in our baseline case.

Daya Prediksi Laba dan Aliran Kas (Studi Empiris pada Perusahaan Manufaktur di Bursa Efek Indonesia Periode 2005-2009)

This study provides information on predictive ability of annual earnings and cash flow from op- eration numbers. We obtained a sample of 42 BEI (Bursa Efek Indonesia) listed companies and 168 observation, year-end firms from 2005 to 2009. We find that both cashflows and earnings numbers have substantially predictive ability for future cashflows. Furthermore, this study doc- uments that cashflows numbers have more predictive ability for future cashflows than earnings and the result are robust. Key words: Earnings, Earnings and Cashflows Prediction, Cashflow.

The Decline In Matching And Earnings Ability To Forecast Operating Cash Flows

Recent research has documented the decline of matching in financial reporting during the last few decades. The FASB has argued that earnings should provide investors and creditors with an ability to assess the amounts, timing, and uncertainty of cash flows to the organization (1978). This research investigates whether the decline in matching has affected the ability of earnings to forecast operating cash flows. Results indicate that earnings from earlier periods in which matching was better can be used to make more accurate predictions of operating cash flows than can earnings from later periods with poorer matching. Additionally, the more frequent recognition of special items in later periods also damages the ability of earnings to predict operating cash flows.

The usefulness of operating cash flow and accrual components in improving the predictive ability of earnings: a re-examination and extension

We examine whether the components of accruals and operating cash flows improve the predictive ability of earnings for forecasting future cash flows. Unlike most previous studies, we avoid data estimation errors and sample self-selection bias because we exploit data from Australia where reporting of actual cash flow components had been mandatory since 1992. We show that accrual components and operating cash flow components together are more useful than (i) earnings, (ii) operating cash flows and total accruals and (iii) the combination of operating cash flows with accrual components in forecasting future cash flows. These results are robust to several contextual factors, including the length of the operating cash cycle, industry membership, firm profitability and firm size.

Accounting data and UK dividends

PurposeAccruals data reflect managers’ judgements and estimates. The purpose of this paper is to examine whether they provide users of accounts with additional insight into a firm's dividends beyond that conveyed by cash flows alone.Design/methodology/approachThe authors employ regression analysis to examine the relative ability of earnings, cash flows and accruals to explain dividends.FindingsIt is found that both cash flows and accruals (earnings) possess significant explanatory power for dividends indicating that, on average, UK financial statements provide users with improved insight beyond that conveyed by cash flows alone.Research limitations/implicationsThese results demonstrate the importance of accruals data for users of accounts. However, if accruals are manipulated for opportunistic purposes then their usefulness will likely be compromised and users of accounts will loose out. The study focuses on non‐financial, UK dividend‐paying firms only.Practical implicationsThese results provide direct evidence that UK financial statement data has significant explanatory power for dividend‐paying activity, which may be viewed as good news. However, this paper reiterates the need for those who prepare and audit accounts to ensure that accruals truly reflect a firm's financial situation and are not being “managed” to artificially boost reported earnings. Short‐term accruals are an obvious focus for such activities.Originality/valueThe paper reports the first direct test of the link between disaggregated earnings components and UK dividends.

TO JOIN OR NOT TO JOIN? DO BANKS THAT ARE PART OF A FINANCIAL HOLDING COMPANY PERFORM BETTER THAN BANKS THAT ARE NOT?

This study compares the performance of banks that are part of a financial holding company (FHC banks) with that of banks that are not (independent banks) using Taiwan data from 2002:Q1 to 2006:Q2. The comparisons are based on 14 performance ratios resulting from the concept of CAMEL (which is an acronym for Capital adequacy, Asset quality, Management efficiency, Earnings ability, and Liquidity sufficiency). To ensure that becoming part of an FHC is a random process, we used four matching methods to select the controlled banks so that the characteristic variables of banks in the two groups are statistically indifferent. By using the data before matching, it was found that FHC banks significantly defeat independent banks, regardless of their performance ratios. Conversely, when the sample was used after the matching, the results changed dramatically. Although FHC banks still beat the independent banks in terms of capital adequacy, asset quality, and liquidity sufficiency, FHC banks and independent banks are found to have equal profitability and management efficiency. Earlier studies that do not consider the endogeneity problem tend to overestimate the joining effect.(JELC21, G21)

EARNINGS PERFORMANCE IN PREDICTING FUTURE EARNINGS AND STOCK PRICE PATTERN

So far, business forecasting has been considered important in almost all economic entitiesand it is often used in areas such as in security analysts, institutional lending, and manage-ment. This research aims at examining empirically the predictability of time series of earn-ings for future earnings and stock price patterns by means of Autoregressive Integrated Mov-ing Average (ARIMA). It is expected to provide contribution in the form of empirical evi-dence, in which earnings are considered useful for predicting earnings and stock price pat-tern. The forecasting is by using some techniques among others, the naive model, regression,ARIMA (Box-Jenkins) and so on. The data were taken from stock market data center at UGMand UTY’s IDX corner during 1996-2007. Based on the sampling criteria, 22 companieswere used as the sample. The results showed that there were no statistically significant dif-ferences among actual earnings for the earnings forecast. The first hypothesis which statesthat there is ability in predicting earnings income is statistically supported. The second hy-pothesis which states that there is the ability of earnings in predicting stock price pattern isalso statistically supported

Daya prediksi laba dan aliran kas (Studi empiris pada perusahaan manufaktur di Bursa Efek Indonesia periode 2005-2009)

This study provides information on predictive ability of annual earnings and cash flow from operation numbers. We obtained a sample of 42 BEI (Bursa Efek Indonesia) listed companies and 168 observation, year-end firms from 2005 to 2009. We find that both cashflows and earn- ings numbers have substantially predictive ability for future cashflows. Furthermore, this study documents that cashflows numbers have more predictive ability for future cashflows than earn- ings and the result are robust. Keywords: Earnings, Earnings and Cashflows Prediction, Cashflow.

Accruals and the prediction of future cash flows

PurposeThe purpose of this paper is to examine the comparative abilities of current period cash flows and earnings (and its components) to predict one‐year‐ahead cash flow from operations in Egypt.Design/methodology/approachThe study uses the cash flow prediction models developed by Barth, Cram, and Nelson to examine the predictive abilities of earnings and cash flows for future cash flows. The first set of prediction models uses cross‐sectional regression to compare the predictive abilities of cash flows and aggregate earnings for one‐year‐ahead cash flow from operations. The second set of prediction models tests whether disaggregating earnings into cash flows and the major components of accruals enhances the predictive ability of earnings for one‐year‐ahead cash flow from operations.FindingsThe findings of the study reveal that aggregate earnings have superior predictive ability than cash flows for future cash flows. Also, the results reveal that disaggregating accruals into major components – changes in accounts receivable and payable, and in inventory, depreciation, amortization, and other accruals – significantly enhances predictive ability of earnings.Research limitations/implicationsThe study provides empirical evidence on the superiority of earnings in predicting future cash flows. The findings of the study should be considered in explaining the results of value relevance research Egypt. However, owing to relatively small sample size, given the thinness of the Egyptian capital market, these findings should be interpreted with caution.Originality/valueThe paper contributes to the limited body of research on the superiority of earnings and cash flows in predicting future cash flows by examining the predictive abilities of earnings and cash flows for future cash flows in Egypt as one of many emerging markets.

Changes in the predictive ability of earnings around earnings restatements

Purpose – The purpose of this paper is to investigate whether earnings restatements have a larger effect on the earnings quality (proxied by persistence) of restating firms relative to similar non‐restating firms and if restated earnings are more persistent than the originally reported earnings.Design/methodology/approach – Cross‐sectional earnings persistence models are used to analyze how earnings persistence changes around restatements for both the originally reported earnings and the new restated earnings numbers. The study looks at restatements from 1997 through 2006.Findings – The findings show that restating firms exhibit a larger increase in earnings persistence from the two‐year period before to the two‐year period after the restatements. Results also show that the restated portion of earnings is incrementally persistent relative to the originally reported earnings and the incremental persistence, although mitigated, is still significant after the passage of the Sarbanes‐Oxley Act. In addition, t...

An Analysis Of The Comparative Predictive Abilities Of Operating Cash Flows, Earnings, And Sales

<p class="MsoBodyText" style="text-align: justify; margin: 0in 34.2pt 0pt 0.5in;"><span style="color: black; font-size: 10pt;"><span style="font-family: Times New Roman;">Prior studies (e.g., Greenburg et al., 1986; Murdoch and Krause, 1989) provide evidence that earnings outperforms historical cash flows in predicting future cash flows. Later research (e.g., Barth et al., 2001) demonstrates that the major accrual components of earnings each possess significant explanatory power in predicting future cash flows and that they augment, rather than replace, the predictive ability of aggregate earnings.<span style="mso-spacerun: yes;">  </span>The current study furthers this work by examining the predictive power of another major component of earnings, i.e., sales.<span style="mso-spacerun: yes;">  </span>Using share price as the dependent variable and as a proxy for future cash flows, this study compares the predictive abilities of changes in operating cash flows, earnings, and sales.<span style="mso-spacerun: yes;">  </span>Similar to the findings in prior research, earnings predicts better than operating cash flows.<span style="mso-spacerun: yes;">  </span>More importantly, however, sales predicts with greater accuracy than either operating cash flows or earnings.</span></span></p>

The Usefulness of Operating Cash Flow and Accrual Components in Improving the Predictive Ability of Earnings: A Re-Examination and Extension

We examine whether the components of accruals and operating cash flows improve the predictive ability of earnings for forecasting future cash flows. Unlike most previous studies, we avoid data estimation errors and sample self‐selection bias because we exploit data from Australia where reporting of actual cash flow components had been mandatory since 1992. We show that accrual components and operating cash flow components together are more useful than (i) earnings, (ii) operating cash flows and total accruals and (iii) the combination of operating cash flows with accrual components in forecasting future cash flows. These results are robust to several contextual factors, including the length of the operating cash cycle, industry membership, firm profitability and firm size.

Discretionary accruals and the predictive ability of earnings in the forecast of future cash flows: Evidence from Australia

We examine whether discretionary and non-discretionary accruals improve the predictive ability of earnings for forecasting future cash flows in an Australian context. Using both within-sample and out-of-sample forecasting tests; we demonstrate that discretionary accruals improve the predictive ability of earnings in the forecast of future cash flows. Further, discretionary and non-discretionary accruals and direct method cash flow components together are more useful than (i) aggregate earnings, (ii) aggregate cash flow from operations and total accruals, and (iii) aggregate cash flow from operations, discretionary accruals and nondiscretionary accruals.

Impact of IFRS in New Zealand on Accounts and Earnings Quality

The impact of the adoption of International Financial Reporting Standards (IFRS) on the accounts and the quality of earnings of New Zealand firms is examined. Our analysis of IFRS adjustments for the last period under pre‐IFRS NZ Generally Accepted Accounting Principles (GAAP) reveals that total assets, total liabilities and net profit were significantly higher under IFRS than under pre‐IFRS GAAP. Profit and equity under IFRS were increased by adjustments for goodwill and other intangibles and investment property, and decreased by adjustments for employee benefits and share‐based payments. Using data for 2002–2009, we find that absolute discretionary accruals were significantly higher under IFRS than under pre‐IFRS NZ GAAP, suggesting lower earnings quality under IFRS than under pre‐IFRS NZ GAAP. However, we find no significant differences in signed discretionary accruals and the ability of earnings to predict one‐year‐ahead cash flows between pre‐IFRS NZ GAAP and IFRS. These results are consistent across alternative measures of accruals quality, sample selection and whether firms elected to adopt IFRS in 2005 rather than comply with them in 2007.

The Comparative Predictive Abilities Of Accrual Earnings And Cash Flows In Periods Of Economic Turbulence: The Case Of The IT Bubble

<p class="MsoNormal" style="text-align: justify; margin: 0in 0.5in 0pt;"><span style="color: black; font-size: 10pt;"><span style="font-family: Times New Roman;">As set forth in SFAC No. 1, a primary objective of financial reporting is to provide information useful to decision makers. Predicting future cash flows represents a major goal of investors and creditors, and accrual and cash flow accounting information present two alternative factors useful in such predictions. The current research investigates the comparative abilities of accrual basis net income and historical cash flows from operations as predictors of future cash flows during both the economic boom leading up to the IT Bubble and the period of economic duress following the burst of that Bubble. Generally, results indicate that historical cash flows outperform accrual net income in predicting future cash flows during these periods of economic turbulence.<span style="mso-spacerun: yes;">  </span>Additionally, the evidence reveals great variability in the predictive ability of accrual earnings during the time period studied, suggesting that accrual accounting estimates lose some of their precision during periods of extreme economic fluctuation. </span></span></p>

Cost of Equity and Risk in Cash Flow and Accrual Components of Earnings

This paper shows that risk in cash flow and accrual components of earnings is an important determinant of a firm’s cost of equity beyond risk in earnings. The paper develops and tests a model that demonstrates how earnings smoothing hinders the ability of earnings to capture firm risk and how cash flows and accruals can be used to unravel the effect of smoothing in estimating firm risk. The model also shows that the sensitivity of firm risk to risk in cash flows and accruals depends on the profit margin and the length of the operating cash cycle. The empirical results are generally consistent with the model findings. Relative to estimates of cost of equity based on volatility of earnings, estimates of cost of equity based on volatilities of cash flows and accruals result in lower valuation errors, lower valuation biases, and better explain future stock returns.

Accounting Conservatism and the Temporal Trends in Current Earnings’ Ability to Predict Future Cash Flows versus Future Earnings: Evidence on the Trade-off between Relevance and Reliability

This research reports that an increasing level of accounting conservatism over the 1973–2005 period is associated with: (1) an increase in the ability of current earnings to predict future cash flows and (2) a decrease in the ability of current earnings to predict future earnings. We also find that usefulness of earnings for explaining stock prices over book values is positively related to reliability but not to relevance. Our results hold for the constant and full samples in both in-sample and out-of-sample analyses and are robust to the use of alternative measures for relevance, reliability, earnings usefulness, and conservatism. Our findings about the relations among conservatism, relevance, reliability, and usefulness suggest a trade-off between relevance and reliability and seem to indicate that the adoption of an increasing number of conservative accounting standards has a possible adverse impact on earnings usefulness through a negative effect on reliability.

Does the Sarbanes-Oxley Act Have an Impact on the Ability of Earnings to Predict Cash Flows? : An Empirical Analyses of SEC Standard Japanese firms

Does the Sarbanes-Oxley Act Have an Impact on the Ability of Earnings to Predict Cash Flows? : An Empirical Analyses of SEC Standard Japanese firms