Uncertainty Of Future Cash Flows Research Articles

Accounting for Uncertainty

Abstract In accordance with the theme of the Yuri Ijiri lectures, I focus on something foundational to accounting: the communication of uncertainty through accounting numbers. I do so in the context of providing information to investors about “the amount, timing, and uncertainty of future cash flows”, an objective of accounting standard setters (with emphasis added). I outline accounting principles that convey uncertainty and discuss the implications for a financial statement analysis that extracts information about uncertainty. I also show how accounting-based valuation is modified to incorporate that information. Asset pricing in finance deals with risk and uses accounting numbers to do so. I explain how that endeavor might be improved by recognizing the accounting for uncertainty. That puts accounting and finance on the same platform. Finally, I address normative issues of accounting policy for conveying information about the uncertainty of future cash flows.

Case study: The Adjusted Valuation of the High-tech Newly-listed Company in Mainland China

Given the enormous contribution of high-tech startups to social development, a systematic approach to accurately evaluate these companies is significant for venture capital firms, equity investors, and other investors in the market. However, the conventional methods, including the cost and income approaches, cannot fulfill the valuation goal without any development due to the insufficient financial information and future uncertainty of these firms. This paper investigates a new valuation method that combines the beta coefficient adjustment and future cash flow scenario discussion. This newly established method is employed to value one of the most influential newly listed semiconductor firms: Semiconductor Manufacturing International Corporation in mainland China. If this new combination works well for firms under such circumstances, analytics could apply similar ideas to handle the lack of historical data and uncertainty of future cash flows.

The Effects of ESG Performance on the Relationship between Tax Risk and Cost of Capital: An Empirical Analysis of Korean Multinational Corporations

Purpose - Using a sample of Korean multinational corporations, we examine whether the relationship between tax risk and the implied cost of capital discriminates between the environmental, social, and corporate governance (ESG) of highly rated firms.
 Design/methodology - Firms with high tax risks have an increased uncertainty of future cash flows. Therefore, as the volatility of future cash flow increases, information asymmetry and the required return increases. Highly rated ESG firms can reduce information asymmetry, thereby weakening the positive relationship between tax risk and cost of capital. We employ the standard deviation of the cash effective tax rate as proxy of tax risk. We utilize the ESG rating data of the Korea Corporate Governance Service (KCGS). We use a PEG model, MPEG model, and GM model to measure the implied cost of capital.
 Findings - We find a positive association between the implied cost of capital and tax risk. The positive relationship between tax risk and the implied cost of capital weakens in highly rated ESG firms. Highly rated ESG firms prefer a stable tax position to invest after-tax cash flows into sustainable management. Therefore, the negative effects of tax risk on cost of capital can be reduced.
 Originality/value - This study provides empirical evidence that ESG activities can mitigate the negative impact of tax risk on the cost of capital for Korean multinational corporations. In a business environment where ESG activities are more important, the empirical results that ESG activities can reduce the corporate risk of Korean FDI companies are expected to provide implications for the ESG activities of multinational corporations.

Accounting for Intangible Assets: Thinking It Through

AbstractWith the modern corporation investing more in intangible assets, the issue of appropriate accounting for these assets is very much at the fore and formally on the agendas of accounting standards boards. Some commentators advocate that internally generated intangible assets should be booked to the balance sheet, just like tangible assets. This paper explains that this apparently straightforward solution is not so simple. There are subtleties that, when recognised, indicate that such accounting would often make both balance sheets and income statements less informative. In response, the paper outlines an accounting for intangible assets that preserves, indeed enhances, the information conveyed by both the balance sheet and the income statement and satisfies the financial reporting objective of providing information to investors about ‘the amount, timing, and uncertainty of future cash flows’.

Alternative investments: Motives and risks for investors on crowdfunding platforms

With the development of financial markets and digital technologies, private companies are starting to actively use alternative financing tools, which, in turn, are becoming an alternative for investors to put money in traditional financial assets. Among these instruments, equity crowdfunding (crowdinvesting) plays a special role, an innovative method of financing through which issuers raise funds on online portals — crowdfunding platforms, and investors make investments in exchange for company shares. The subject of many academic and practical studies is the motives and risks of investing in this instrument. Due to the information asymmetry that exists between issuers and investors, the high uncertainty of future cash flows, the dominance of nonprofessional investors in the market, and a short history of the equity crowdfunding market, currently the issues of investors’ motives and risks remain poorly studied and the results of research are mixed. The purpose of this study was to identify and analyze the motives for investing in shares of small and medium-sized businesses on crowdfunding platforms, the risks associated with them, and the relationship between investment motives and characteristics of investors and crowdfunding campaigns. The research methodology was based on a review of contemporary studies on the issues under consideration. Based on the academic concepts, the experience of experts in this field and the authors’ own expertise acquired in the field of alternative investments, the authors put forward their own view building on the existing ideas. The results of the study are valuable for all participants of the equity crowdfunding process: issuing companies, investors, crowdfunding platforms. The authors contribute to the existing research on equity crowdfunding by proposing new approaches to identification of the motives of different categories of investors in relation to the factors which were not previously studied.

Real earnings management and idiosyncratic return volatility

PurposeHigher real earnings management (REM) reduces financial reporting quality and increases the uncertainty of future cash flows and profitability among investors. This study asserts that REM-induced noise increases idiosyncratic return volatility (IVOL), aims to examine the association between REM and IVOL and further investigates whether information asymmetry, firm life cycle and economic policy uncertainty (EPU) moderate the association between REM and IVOL.Design/methodology/approachThe authors use 94,445 firm-year observations from the US over 1987 to 2019 and test this study’s hypotheses using ordinary least square regressions with robust standard errors clustered by firm. The authors use change analysis, two-stage models and the impact threshold of the confounding variable analysis to address endogeneity.FindingsThe authors find that REM increases IVOL. This positive association is more pronounced for firms with more information asymmetry, for firms in the mature stage of the life cycle, compared with their growth-stage counterparts; and during periods of high EPU.Originality/valueExtant research suggests that accrual manipulation increases IVOL. However, the shift from accrual manipulation to REM and the managerial preference towards REM suggests that it is important to explore the impact of REM on IVOL. Thus, the authors enhance the understanding of the impact of earnings management on IVOL by documenting that REM-induced noise increases IVOL. The authors further extend the limited research on the consequences of REM and report an adverse consequence.

Protection of trade secrets and value of cash holdings: Evidence from a natural experiment

We examine whether the protection of trade secrets by restricting the mobility of knowledgeable employees through the adoption of the legal Inevitable Disclosure Doctrine (IDD), an exogenous event, increases the marginal value of corporate cash holdings by reducing the uncertainty of future cash flows, and how that value differs across firms in IDD recognizing and non- recognizing states. We find that the marginal value of cash holdings increases (decreases) significantly in states in which the IDD has (not) been recognized through increases (decreases) in firm value and performance. A battery of robustness tests reveals that the effect of the IDD is more pronounced in firms with high R&D activities. Overall, the evidence shows that the IDD acts as a mechanism that inhibits the mobility of key employees and, thus, reduces the probability of the misappropriation of knowledge-based human capital assets. That is, the IDD creates an opportunity for firms to efficiently use cash to increase firm value - rather than using cash to protect trade secrets from rivals.

Academic Tenure, Income Uncertainty, and Real Estate Risk-Taking

While real estate investment via home ownership is inherently risky for all owners, individual households face varying degrees of risk that may affect the decision to rent versus own. The uncertainty of future cash flows to an enterprise or household is likely to influence investment behavior in large, long-lived capital such as real estate. This study uses a unique data set of university professors to estimate risk preference sensitivity to changes in the degree of uncertainty of labor income. A structural modeling econometric approach indicates that nontenured professors, who have the least secure incomes, are 33% less likely to own a home than their tenured colleagues, despite having similar average incomes. For those with tenure, 38% of their home ownership can be explained by academic tenure. Our calculations indicate that 124,729 tenured professors decided to purchase a home solely because of the job security tenure entails: roughly .2% of the total U.S. national housing stock.

Fair Value Accounting and Corporate Reporting in Nigeria: A Logistics Regression Approach

This study examined the impact of fair value accounting on corporate reporting in Nigeria. The primary data used were gathered through a well-structured questionnaire, designed and administered to 120 respondents, who are made up of accountants, auditors, bankers, financial experts and practitioners in Lagos State, Nigeria. We adopted the logistic regression approach in analyzing the research questions. We found that fair value accounting has impact on corporate reporting. The Cox and Snell’s R-Square revealed that 67.1% of the variation in the corporate reporting was explained by the logistic model. We further found a moderate strong relationship between the fair value accounting and corporate reporting. Based on this finding, the study concluded that the used of fair value helped in predicting the earnings and assessment of the amounts, timing and uncertainty of future cash flows in corporate reporting which dependent on its reliability. However, institutional factors played an essential role in enhancing the reliability of discretionary fair value estimates which in return increased the informativeness of accounting information in corporate reporting.

Moving the Conceptual Framework Forward: Accounting for Uncertainty

ABSTRACTTo meet the objectives of financial reporting in the IASB's Conceptual Framework, the “balance‐sheet approach” embraced by the Framework is necessary but not sufficient. Critical, but largely overlooked, is the role of uncertainty, which we argue defines the role of accrual accounting as a distinctive source of information for investors when investment outcomes are uncertain. This role is in some sense paradoxical: on the one hand, uncertainty undermines both the balance sheet (because uncertain assets are unrecognized) and the income statement (because mismatching is unavoidable). However, these inevitable accounting effects can be exploited to provide information about uncertainty, though not by a balance‐sheet approach alone. Rather, balance sheet recognition and measurement criteria are established by consideration of the impact of uncertainty on matching and mismatching in the income statement. This combination of balance‐sheet and income‐statement approaches enhances the communication of information to investors under conditions of uncertainty, thereby giving greater clarity and purpose in satisfying the objective of the Framework to provide information about “the amount, timing, and uncertainty of future cash flows.”

A Matter of Principle: Accounting Reports Convey Both Cash-Flow News and Discount-Rate News

This paper modifies the standard returns-earnings regression in accounting research to show that financial reports convey both cash-flow news and discount-rate (expected-return) news. The paper points to the realization principle, associated as it is with the resolution of risk, as the accounting feature that conveys expected-return news. The modified returns-earnings regressions indicate that the information so conveyed pertains to priced risk. In corroboration, the paper also shows that the identified expected-return news forecasts changes in both stock return betas and earnings betas, and expected-return news predicts future returns, whereas cash-flow news does not. The analysis yields a number of additional insights: financial statements distinguish expected-return news associated with operations from that associated with financing activities; given accounting information, there is not much news in dividends; and, in comparing the information content of earnings versus cash flows, cash flows largely convey expected-return news rather than cash-flow news. In sum, the paper shows that the objective of the Financial Accounting Standards Board and International Accounting Standards Board to provide information about the amount and uncertainty of future cash flows is (as least, partially) satisfied by accounting principles underlying current financial reporting. This paper was accepted by Suraj Srinivasan, accounting.

Do Lenders Price Tax Risk in the Debt Contract?

We investigate the relation between tax risk and the cost of private debt. Tax risk can lead to significant negative outcomes, including penalties, interest and additional tax payments, which in turn can increase the uncertainty of future cash flows and make it costlier for a firm to borrow. Consistent with our hypothesis, we find a significant, positive relation between the cost of borrowing and tax risk. In terms of economic significance, a one percent increase in our tax risk measure implies an interest rate increase of 4.04 basis points. We also find that lenders are more likely to require collateral, include more covenants, and issue smaller loans when borrowers have higher tax risk.

Can Targets Benefit from Negotiations? Evidence from Auctions and Negotiations

Recent research suggests that target shareholders’ wealth effects from auctions do not differ from their wealth effects in single-bidder negotiations (Boone and Mulherin, 2007b). We find this result puzzling and contend that an analysis of the method of sale decision and the wealth effects outcome must address the self-selection bias resulting from target management’s private information inherent in the decision. Using a self-selection framework, we hypothesize that adverse selection risk (i.e., an anticipated risk) and the uncertainty of future cash flows (i.e., an unknown risk) impact the target’s decision to sell through an auction, as well as the wealth accruing to target shareholders. We find that when target managers initiate the sale of the firm, they are more likely to choose an auction as the method of sale. Our results suggest that the method of sale (i.e., selling the firm through an auction or negotiating with a single bidder) is not random and has a significant impact on the wealth of target shareholders. Specifically, both under a self-selection framework and in deal initiator subsample analysis, we find that adverse selection risk, including a lack of transparency in financial reporting and the uncertainty of future cash flows, impacts the target’s decision to sell through an auction as well as the wealth accrued to target shareholders. Auctions are associated with both higher target cumulative abnormal returns and offer premiums than negotiations, but only if the transaction is not initiated by the target. The target can self-select itself and choose an auction (vs. negotiation) to increase target wealth effects. We also show that controlling for both simultaneity and self-selection biases enriches our understanding of the corporate takeover process.

To Fair Value or Not to Fair Value: A Broader Perspective

Fair value is considered here with respect to the two primary objectives of financial statements proposed in the joint conceptual framework that is under development by the FASB and the IASB, namely (a) informativeness—to assist providers of capital in predicting, evaluating, and comparing the amounts, timing and uncertainty of future cash flows, and (b) stewardship—to assist in evaluating how efficient and effective managers have been in enhancing shareholders’ value. More specifically, a comprehensive set of accounting measures and a set of corporate governance reforms intended to align corporate insiders’ and auditors’ behaviour and decisions with the interests of investors is outlined. Suggested reforms show how to present a mix of effectively historical quantifications, exit values, and the discounted values of future cash flows expected from the particularized use of combinations of assets within the firm. Additionally, the article describes how markets can be reformed in order to align the interests of the officers who prepare such accounts, and the auditors who certify them, with those of investors. These market‐based reforms would require auditors to insure misrepresentations, and managers to take equity to induce truthful reporting. Also included is a radical extension to earlier proposals by the author, requiring an officer of the company to make the market in shares in a way that would place limits upon the value of the insider's private information.

Economic Values and Corporate Financial Statements

Corporate financial statements do not include environmental values. This deficiency has contributed to the criticism that company managers do not include environmental impacts in the internal decision-making process. The accounting profession has not developed effective environmental reporting guidelines. This situation contributes to a second problem: the apparent inability of corporate reports to provide useful information to external parties. It has been suggested that by using nonmarket valuation methodologies, financial statements can be used to measure progress toward sustainable development. Nonmarket valuations are not generally accepted by the accounting profession. They are too subjective to support effective decisions, and too costly to obtain. Furthermore, demand for this sort of information appears small. Some of these issues may be resolved over time. The most serious challenge, however, concerns how enhanced financial reports would be used. Financial statements are supposed to help investors assess the amount, timing, and uncertainty of future cash flows. A substantial portion of environmental value is based on nonuse benefits, much of which will never be realized in company cash flows. In other words, the role of financial statements would have to change. Furthermore, since there is no general agreement as to the meaning of "sustainable development," efforts to operationalize the term have been fraught with difficulty. Moreover, monetization of environmental values could jeopardize their preservation, leaving some to question the overall objective of this form of reporting. For these reasons, while it is to be hoped that better reporting of environmental impacts will be forthcoming, the greatest advances will likely be outside the financial statements themselves.

Price uncertainty and corporate value

This study examines the sensitivity of equity values of oil producers to changes in the uncertainty of future oil prices. We document that this sensitivity is negatively correlated with a firm's debt ratio and its production costs. These results indicate that companies that are more likely to experience financial distress or underinvestment from low cash flows are adversely affected by increases in the uncertainty of future cash flows. We conclude that corporate risk management can increase shareholder value by reducing the expected costs of financial distress and underinvestment.

Valuing Flexibility in Private Toll Road Development

The emergence of alternative project delivery and finance methods in developing and sustaining infrastructure assets increases the significance of valuing such facilities. As private participants are introduced into the delivery of public facilities, the balance of possible future cash flows with initial capital inflows is an essential aspect of ensuring project viability. Traditional valuation techniques, which provide a tangible basis for the ultimate investment decision, often are employed in project financial analysis. The uncertainty of future cash flows, however, presents unique challenges for the use of these traditional methods. Moreover, the active management and planning of infrastructure projects creates flexibility that is largely ignored by traditional valuation methods. The Dulles Greenway, a recent private highway venture, provides a perspective to understand how “options” are used intuitively throughout a large-scale project and how the “option” to wait and resolve uncertainty can be valued with simple techniques that supplement traditional valuation methods. This article retrospectively analyzes project cash flows and the decision to invest in the Dulles Greenway.

Price Uncertainty and Corporate Value

This study examines the sensitivity of equity values of oil producers to changes in the uncertainty of future oil prices. We document that this sensitivity is negatively correlated with a firm's debt ratio and its production costs. These results indicate that companies that are more likely to experience financial distress or underinvestment from low cash flows are adversely affected by increases in the uncertainty of future cash flows. We conclude that corporate risk management can increase shareholder value by reducing the expected costs of financial distress and underinvestment.

Using Operating Cash Flow Data to Predict Financial Distress: Some Extensions

Recently, financial statement users and regulators of publicly reported financial accounting data have argued in favor of disclosure of detailed information on firms' current operating cash flows (Harris et al. [1980], FASB [1981], Smith [1982], and Thomas [1982]). The FASB suggests that such disclosures will allow users to assess better amount, timing, and uncertainty of future cash flows. It states that the greater amount of future net cash inflows from operations, greater ability of enterprise to withstand adverse changes in operating conditions [1981, p. 11]. The presumption that historical operating cash flows enable better assessments of future cash flows, however, is based on intuition rather than on empirical evidence (Griffin [1982]). Our study was conducted to assess whether operating cash flow data and related measures lead to more accurate predictions of bankrupt and

Capital Budgeting with Uncertain Future Opportunities: A Markovian Approach

The importance of an explicit consideration of uncertainty in evaluating the economic desirability of investment propositions is generally recognized in contemporary literature on capital budgeting. The emphasis has been on analyzing the effects of uncertainty of future cash-flows which result from an investment on the economic desirability of that investment. However, although future cash-flows are one important source of uncertainty, it should be recognized that other factors may contribute to uncertainty in a significant way. Uncertainty regarding alternate future investment opportunities is of obvious importance in the capital budgeting context. Thus, an investor who makes the best possible investment decision at a given point in time may deplore such a decision a short time afterward simply because his commitment prevents him from exploiting a better opportunity. While it might be assumed implicitly that an investor, in considering his alternatives, ought to include in such deliberations all the courses of action that may become available in the future, this aspect seems important enough to warrant explicit attention.