This paper augments the Jones (1991) model with operating cash flows and lagged accruals to evaluate the impact of (1) the negative association between accruals and concurrent cash flows, (2) the positive association between accruals and lagged cash flows, and (3) the reversal of accruals. I find that operating cash flows greatly improve the explanatory and predictive power of the Jones model; but, lagged accruals do not. A market test of the expected and unexpected components of accruals indicates that unexpected accruals are on average informative with respect to concurrent stock returns; however, the market does not fully understand the implications of accruals anticipated at the beginning of the return period. Copyright Springer Science + Business Media, Inc. 2005unexpected accruals, expected accruals, discretionary accruals, non-discretionary accruals, Jones model, reversals of accruals,
This study adds change in cash investments and change in lagged operating assets to the regression of returns on earnings levels and earnings changes examined in Easton and Harris (1991). We argue that a positive coefficient on change in cash investments captures conservatism associated with investments in positive net present value projects the effects of which will not flow into the accounting statements until the expected future benefits are realized. A positive coefficient on change in lagged operating assets implies accounting conservatism associated with the application of accounting rules to operating assets in place. Our empirical results are, in general, consistent with these arguments. We examine differences in conservatism across samples with different market to book ratios, we compare firms with non-negative returns with firms with negative returns, we compare firms reporting losses with firms reporting profits, and we examine firms in different industries, firms with different levels of research and development expenditure, different amounts of depreciation, different amounts of advertising expense, and firms that adopt LIFO inventory valuation compared with those that adopt an alternative to LIFO.Numerous studies use the regression of returns on earnings (deflated by beginningof-period stock price) and deflated earnings changes introduced by Easton and Harris (1991) as the basis for tests of the value relevance of accounting. For example, Alford et al. (1993) use the R 2 from this regression to compare the value relevance of GAAP across sixteen countries, and Francis and Schipper (1999) use the change in the R 2 and change in the coefficients on earnings and earnings changes as indications of the change in the value relevance of U.S. financial statements over time.The foundation of the Easton and Harris (1991) regression of returns on earnings (deflated by beginning-of-period stock price) and deflated earnings changes is a model that expresses price as a linear function of book value and earnings. The key contribution of this model, which is formally described in Ohlson (1995), is that it provides a role for the balance sheet as well as the income statement (which had been the focus of prior studies). The shortcoming, however, is that does not incorporate the conservative accounting principles under which the GAAP balance sheets are constructed. We estimate earnings-return regression specifications that not only
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