Quarterly Earnings, Operating Cash Flow, and Accruals in Future Performance Assessment

Pimentel, Rene Coppe; Malacrida, Mara Jane Contrera

doi:10.1590/1807-7692bar2020190115

Rene Coppe Pimentel ^** Corresponding author

Universidade de São Paulo, São Paulo, SP, Brazil

Authors Rene Coppe Pimentel, Universidade de São Paulo, Av. Luciano Gualberto, 908 FEA 3, 05508-010, São Paulo, SP, Brazil. renecp@usp.br

http://orcid.org/0000-0002-8845-049X

Mara Jane Contrera Malacrida

Universidade de São Paulo, São Paulo, SP, Brazil

Mara Jane Contrera Malacrida, Universidade de São Paulo, Av. Luciano Gualberto, 908 FEA 3, 05508-010, São Paulo, SP, Brazil. maracont@usp.br

http://orcid.org/0000-0002-1157-6799

* Corresponding author

Editor-in-chief: Carlo Gabriel Porto Bellini / (Universidade Federal da Paraíba, João Pessoa, PB, Brazil)

Associate editor: Robert Iquiapaza / (Universidade Federal de Minas Gerais, Belo Horizonte, MG, Brazil)

Reviewers: Rafael Moreira Antônio / (Universidade de São Paulo, Ribeirão Preto, SP, Brazil), Paulo Roberto Barbosa Lustosa / (Universidade de Brasília, Brasília, DF, Brazil) and one anonymous reviewer

Editorial assistants: Kler Godoy and Simone Rafael (ANPAD, Maringá, PR, Brazil)

Authors’ contributions

1^st author: conceptualization (equal), data curation (equal), formal analysis (lead), investigation (lead), methodology (lead), project administration (equal), resources (equal), supervision (equal), writing-original draft (supporting), writing-review & editing (supporting).

2^nd author: conceptualization (equal), data curation (supporting), formal analysis (supporting), project administration (equal), resources (equal), supervision (equal), validation (equal), writing-original draft (supporting), writing-review & editing (supporting)

Authors

Rene Coppe Pimentel, Universidade de São Paulo, Av. Luciano Gualberto, 908 FEA 3, 05508-010, São Paulo, SP, Brazil. renecp@usp.br

Mara Jane Contrera Malacrida, Universidade de São Paulo, Av. Luciano Gualberto, 908 FEA 3, 05508-010, São Paulo, SP, Brazil. maracont@usp.br

Variable	Symbol	Expected signal	Author	Economic interpretation
Extreme earnings and operating cash flows	dbigearn	-	Easton and Zmijewski (1989)Easton, P. D., & Zmijewski, M. E. (1989). Cross-sectional variation in the stock market response to accounting earnings announcements. Journal of Accounting and Economics, 11(2), 117-141. https://doi.org/10.1016/0165-4101(89)90003-7 https://doi.org/10.1016/0165-4101(89)900... ; Leal et al. (2017)Leal, L. T. Y., Girao, L. F. D. A. P., Lucena, W. G. L., & Martins, V. G. (2017). Persistence, value relevance, and accruals quality in extreme earnings and cash flow situations. RAM. Revista de Administração Mackenzie, 18(3), 203-231. http://dx.doi.org/10.1590/1678-69712017 http://dx.doi.org/10.1590/1678-69712017...	Extreme values of earnings and operating cash flows are typically transitory and non-recurrent elements in their nature. These elements are not assumed to persist throughout the period (for instance, a big loss or gain due to an unexpected event or specific condition). Thus, the presence of extreme values should be negative related to the persistence of financial performance.
Extreme earnings and operating cash flows	dbigcfo	-
Decrease earnings and operating cash flows	decrearn	-	Chen (2013)Chen, C. (2013). Time‐varying earnings persistence and the delayed stock return reaction to earnings announcements. Contemporary Accounting Research, 30(2), 549-578. https://doi.org/10.1111/j.1911-3846.2012.01165.x https://doi.org/10.1111/j.1911-3846.2012...	Managers should pursue wealth maximization of stakeholders. Consequently, firms should run their activities expecting maximization of their economic outputs. Decrease in earnings or operating cash flows in a given period should make managers take actions to revert it to increasing figures in the shortest period possible. Thus, the presence of decrease earnings of operating cash flows should be negatively related to the persistence of financial performance.
Decrease earnings and operating cash flows	decrcfo	-
Negative earnings and operating cash flows	dnegearn	-	Chen (2013)Chen, C. (2013). Time‐varying earnings persistence and the delayed stock return reaction to earnings announcements. Contemporary Accounting Research, 30(2), 549-578. https://doi.org/10.1111/j.1911-3846.2012.01165.x https://doi.org/10.1111/j.1911-3846.2012...	Similar to decrease in earnings, losses are not associated with the wealth maximization view, especially in persistent losses. Hence, the presence of loss or negative operating cash flows in a given period should make managers take actions to revert it to positive figures in the shortest period possible. Thus, the presence of negative earnings should be negatively related to the persistence of financial performance. Note that a period of decreasing in earnings does not necessarily mean negative earnings and a period of negative earnings does not mean a period of decreasing in earnings. One is related to earnings 'movement,' the other with earnings 'realization.'
Negative earnings and operating cash flows	dnegcfo	-
Volatility of earnings and operating cash flows	voleran	-	Clubb and Wu (2014)Clubb, C., & Wu, G. (2014). Earnings volatility and earnings prediction: Analysis and UK Evidence. Journal of Business Finance & Accounting, 41(1-2), 53-72. https://doi.org/10.1111/jbfa.12055 https://doi.org/10.1111/jbfa.12055... ; Frankel and Litov (2009)Frankel, R., & Litov, L. (2009). Earnings persistence. Journal of Accounting and Economics , 47(1), 182-190. https://doi.org/10.1016/j.jacceco.2008.11.008 https://doi.org/10.1016/j.jacceco.2008.1...	More volatile earnings or operating cash flows mean that the presence of transitory components is common in the time series process. The firms operating in more stable activities (such as utilities) are less exposed to variation due to other variables such as commodities or other macroeconomic conditions. Thus, more volatile earnings should be negatively related to the persistence of financial performance.
Volatility of earnings and operating cash flows	volcfo	-
IFRS	IFRS	+/-	Barth, Landsman, and Lang (2008)Barth, M. E., Landsman, W. R., & Lang, M. H. (2008). International accounting standards and accounting quality. Journal of Accounting Research, 46(3), 467-498. https://doi.org/10.1111/j.1475-679X.2008.00287.x https://doi.org/10.1111/j.1475-679X.2008... ; Byard, Li, and Yu (2011)Byard, D., Li, Y., & Yu, Y. (2011). The effect of mandatory IFRS adoption on financial analysts’ information environment. Journal of Accounting Research , 49(1), 69-96.https://doi.org/10.1111/j.1475-679X.2010.00390.x https://doi.org/10.1111/j.1475-679X.2010...	The literature offers two expectations to this variable. On the one hand, the IFRS adoption might have increased the quality of accounting information and relevance, and, thus, a positive effect is expected, once we assume that more persistence is related to better accounting information (Dechow et al., 2010Dechow, P., Ge, W., & Schrand, C. (2010). Understanding earnings quality: A review of the proxies, their determinants and their consequences. Journal of Accounting and Economics, 50(2-3), 344-401. http://dx.doi.org/10.1016/j.jacceco.2010.09.001 http://dx.doi.org/10.1016/j.jacceco.2010... ). On the other hand, authors argue that the IFRS can incorporate more volatility in the financial statements due to inclusion of fair value measures in the asset-liability view (Kusano, 2012Kusano, M. (2012). Does the balance sheet approach improve the usefulness of accounting information? The Japanese Accounting Review, 2(2012), 139-152. https://doi.org/10.11640/tjar.2.2012_139 https://doi.org/10.11640/tjar.2.2012_139... ).

Panel A - Description of the variables
Variable	Obs.	Mean	Std. dev.	Min.	5%	50%	95%	Max.
Earnings (earn)	10,792	-0.006	0.233	-7.200	-0.070	0.007	0.047	12.421
Oper. cash flow (cfo)	10,792	0.007	0.252	-12.048	-0.053	0.015	0.072	12.476
Accruals (accr)	10,792	-0.014	0.220	-6.818	-0.096	-0.009	0.061	11.608
Panel B - Pearson and Spearman correlations
	Earnings (earn)		Oper. cash flow (cfo)			Accruals (accr)
Earnings (earn)			0.348***			0.373***
Oper. cash flow (cfo)	0.592***					-0.625***
Accruals (accr)	0.382***		-0.518***
Panel C - Distributional characteristics of firm-specific persistence parameter (α₁)
	Earnings (earn)		Oper. cash flow (cfo)			Accruals (accr)
Mean	0,175		0,025			0,031
Std. deviation	0,241		0,258			0,238
5th percentile	-0,191		-0,425			-0,363
25th percentile	0,022		-0,137			-0,116
50th percentile	0,136		0,028			0,036
75th percentile	0,349		0,182			0,172
95th percentile	0,585		0,438			0,437

	Earnings persistence					Cash flow persistence
	Base model (Eq. 1a)		Extended model (Eq. 2a)			Base model (Eq. 1b)	Extended model (Eq.2b)
Constant	-0.001		-0.001		Constant	0.008	0.009	*
	(-0.12)		(-0.45)			(0.93)	(1.66)
SDE_t-1	0.134	***	0.480	***	SDCt_-1	-0.010	0.048
	(13.12)		(4.26)			(-0.99)	(0.61)
SDE _t-1dbigearn_t-1*			-0.165	*	SDC_t-1dbigcfo_t-1*		-0.070
			(-1.71)				(-1.08)
SDE _t-1decrearn_t-1*			-0.055		SDC_t-1decrcfo_t-1*		0.109	*
			(-0.80)				(1.63)
SDE _t-1 negearn_t-1*			-0.006		SDC_t-1negcfo_t-1*		0.002
			(-0.10)				(0.04)
SDE _t-1volear_t-1*			0.047		SDC_t-1volcfo_t-1*		-0.008
			(0.66)				(-0.14)
SDE t-1ifrst*			-0.182	***	SDC_t-1ifrs_t*		-0.054
			(-2.97)				(-1.13)
Time controls	yes		yes			yes	yes
Observations	9,353		9,353			9,353	9,353
R-squared	0.035		0.038			0.001	0.009
F	6.8	***	4.3	***		1.3	1.3	*

	Earnings persistence extended model (Eq. 2a)					Cash flow persistence extended model (Eq. 2a)
	High accruals (top 25%)		Low accruals (bottom 25%)			High accruals (top 25%)		Low accruals (bottom 25%)
Constant	-0.001		-0.001		Constant	0.006		-0.001
	(-0.23)		(-0.72)			(1.59)		(-0.81)
SDE_t-1	0.769	**	0.447	***	SDC_t-1	-0.144		0.070
	(2.08)		(2.73)			(-0.58)		(0.62)
SDE _t-1dbigearn_t-1*	-0.310		-0.138		SDC_t-1dbigcfo_t-1*	0.027		-0.024
	(-0.90)		(-1.10)			(0.12)		(-0.27)
SDE t-1decrearnt-1*	0.000		-0.197	**	SDC_t-1decrcfo_t-1*	0.220	**	-0.114
	(0.00)		(-2.12)			(1.81)		(-1.12)
SDE _t-1 negearn_t-1*	0.036		0.031		SDC_t-1negcfo_t-1*	0.085		-0.071
	(0.34)		(0.45)			(0.89)		(-0.82)
SDE _t-1volear_t-1*	0.009		0.031		SDC_t-1volcfo_t-1*	-0.027		-0.119
	(0.10)		(0.20)			(-0.44)		(-0.54)
SDE _t-1ifrs_t*	-0.350	***	-0.159	*	SDC_t-1ifrs_t*	-0.140		0.079
	(-2.50)		(-1.63)			(-1.16)		(1.19)
Quarter controls	Yes		yes			yes		yes
Observations	2,270		2,373			2,270		2,373
R-squared	0.024		0.038			0.017		0.014
F	3.3	***	3.4	***		2.1	**	1.8	*

Panel A - Relationship between future earnings with current accruals and cash flows (Eq. 3)
	t+1		t+2		t+3		t+4
Constant (γ₀)	0.001		0.001		0.001		0.001	***
	(1.55)		(1.44)		(1.45)		(2.61)
SDC (γ₁)	0.119	***	0.097	***	0.042	***	-0.283	***
	(9.73)		(7.83)		(3.35)		(-23.11)
SDA (γ₂)	0.084	***	0.051	***	0.040	***	-0.272	***
	(10.02)		(6.07)		(4.60)		(-32.13)
Observations	9,353		9,079		8,820		8,584
R-squared	0.012		0.007		0.002		0.108
F	58.1	***	31.19	***	10.63	***	516.69	***
Panel B - Relationship between future earnings with current accruals and earnings (Eq. 4)
	t+1		t+2		t+3		t+4
Constant (γ^*₀)	0.001	*	0.001		0.001		0.001	**
	(1.68)		(1.56)		(1.52)		(2.28)
SDE (γ^*₁)	0.159	***	0.095	***	0.019		-0.337	***
	(12.70)		(7.45)		(1.51)		(-27.09)
SDA (γ^*₂)	-0.024	***	-0.025	***	0.014	*	-0.027	***
	(-3.29)		(-3.35)		(1.79)		(-3.79)
Observations	9,353		9,079		8,820		8,584
R-squared	0.019		0.006		0.001		0.127
F	91.53	***	28.28	***	6.15	***	622.12	***

Panel A - Direct effect of accruals on adjacent and seasonal accruals
	t+1		t+2		t+3		t+4
Constant (δ₀)	0.006	**	0.007	**	0.003		0.003
	(2.30)		(2.46)		(1.48)		(1.16)
cfo_t (δ₁)	0.225	***	0.137	***	0.013	***	0.202	***
	(19.20)		(10.94)		(19.38)		(14.50)
cfo_t-3 (δ₂)	0.182	***	0.111	***	0.015	***	0.293	***
	(13.68)		(7.89)		(9.41)		(19.11)
accr_t (δ₃)	0.061	***	0.094	***	0.015	***	0.141	***
	(4.64)		(6.36)		(7.74)		(8.43)
accr_t-1 (δ₄)	0.122	***	0.059	***	0.018	***	0.025
	(7.71)		(3.46)		(-3.54)		(1.26)
Observations	9,648		9,374		9,106		8,839
R-squared	0.0746		0.0253		0.0779		0.0829
F	195.390	***	60.89	***	192.14	***	200.79	***
Panel B - Variance decomposition of future operating cash flow (in %)
One quarter ahead (quarter-by-quarter)					Four quarters ahead (quarter-on-quarter)
	All observ.	High accruals	Low accruals			All observ.	High accruals	Low accruals
earn (%)	1.4	2.3	1.3		earn (%)	2.3	4.8	2.2
cfo (%)	3.0	4.0	3.0		cfo (%)	1.3	2.4	1.3
Total lagged (%)	4.4	6.2	4.3		Total lagged (%)	3.5	7.2	3.5

Panel A - Base model autoregressive parameters
Adjacent (t-1)						Seasonal (t-4)

		Earnings (earn)		Op. cash flow (cfo)		Earnings (earn)			Op. cash flow (cfo)
Constant		-0.011 **		0.001		-0.011 **			0.002
		(-2.35)		(0.24)		(-2.33)			(0.31)
AR parameter		0.285 ***		0.200 ***		0.340 ***			0.166 ***
		(30.36)		(20.85)		(29.90)			(15.71)
Period controls		yes		yes		yes			yes
Obs.		10,483		10,483		9,675			9,675
R-squared		0.081		0.040		0.085			0.025
F		231.3		109.4		224.2			62.1
Panel B - Extended model autoregressive parameters
Adjacent (t-1)						Seasonal (t-4)
	Earnings (earn)			Cash flow (cfo)			Earnings (earn)			Cash flow (cfo)
Const.	-0.002		Const.	0.010	*	Const.	-0.002		Const.	0.003	***
	(-0.43)			(1.75)			(-0.35)			(0.47)
earn_t-1	0.646	***	cfo_t-1	0.487	***	earn_t-4	0.631	***	cfo_t-4	0.690	***
	(3.72)			(3.40)			(3.38)			(4.35)
ear_t-1 dbigearn_t-1*	-0.680	***	cfo_t-1* dbigcfo_t-1	-0.520	***	ear_t-4* dbigearn_t-4	-0.663	***	cfo_t-4* dbigcfo_t-4	-0.667	***
	(-3.92)			(-3.64)			(-3.55)			(-4.21)
ear_t-1 decrearn_t-1*	0.086		cfo_t-1* decrcfo_t-1	-0.348	***	ear_t-4* decrearn_t-4	-0.344	***	cfo_t-4* decrcfo_t-4	-0.300	***
	(1.55)			(-3.23)			(-5.99)			(-2.54)
ear_t-1 negearn_t-1*	0.417	***	cfo_t-1* negcfo_t-1	0.703	***	ear_t-4* negearn_t-4	1.062	***	cfo_t-4* negcfo_t-4	0.510	***
	(7.37)			(6.44)			(18.28)			(4.27)
Period controls	yes			yes			yes			yes
Obs	9,384			9,384			8,584			8,584
R-squared	0.146			0.079			0.187			0.036
F	228.34	***		115.2	***		281.74	***		45.72	***

\begin{matrix} {SDE}_{it} = α_{0} + α_{1} {SDE}_{it - 1} + α_{2} {SDE}_{it - 1} * {dbigearn}_{it - 1} + α_{3} {SDE}_{it - 1} * \\ {decrearn}_{it - 1} + α_{4} SDE * {dnegearn}_{it - 1} + α_{5} {SDE}_{it - 1} * {volearn}_{it - 1} + \\ α_{6} {SDE}_{it} * {ifrs}_{t} + ε_{ti} \end{matrix}

\begin{matrix} {SDC}_{it} = α_{0}^{*} + α_{1}^{*} {SDC}_{it - 1} + α_{2}^{*} {SDC}_{it - 1} * {dbigcfo}_{it - 1} + α_{3}^{*} {SDC}_{it - 1} * \\ {decrcfo}_{it - 1} + α_{4}^{*} {SDC}_{it - 1} * {dnegcfo}_{it - 1} + α_{5}^{*} {SDC}_{it - 1} * {volecfo}_{it - 1} + \\ α_{6}^{*} {SDC}_{it} * {ifrs}_{t} + ε_{ti} \end{matrix}

[1] * Corresponding author

Brasil

Brasil

Quarterly Earnings, Operating Cash Flow, and Accruals in Future Performance Assessment

ABSTRACT