Do investors value smooth performance?☆

Abstract

This paper presents empirical evidence that cash-flow volatility is negatively valued by investors. The magnitude of the effect is substantial with a 1% increase in cash-flow volatility, resulting in approximately a 0.15% decrease in firm value. We show that this increase, however, is not associated with earnings-smoothing resulting from managers" accrual estimates. Our results are consistent with a preference by the market for less volatile cash flows and suggest that managers' efforts to produce smooth financial statements add value, but only via the cash component of earnings.

Impact of Earnings Smoothness on Stock Prices, Stock Returns and Future Earnings Changes - the Polish Experience

“…Indeed, many studies confirm the existence of a negative statistical relationship between variability of earnings and stock values (Barth et al 1999;Hunt et al 2000;Francis et al 2004;Rountree et al 2008;Allayannis and Simko 2009;Chen 2009). Moreover, this negative relationship remains after controlling for cash flow volatility, which confirms that smoothness of accrual-based numbers (and not only cash flows) matters for stock prices (Barnes 2001;Mäkelä 2012).…”

How Can We Increase Shareholder' Wealth? An Empirical Validation from European Countries

“…The dependent variable ISSN 2162-4860 2017 Firm value: according to the work of Demsetz and Villalonga (2001) and Hillier and McColgan (2001), shareholder wealth is measured alternatively by two ratios: -Tobin's Q ratio approximated as the sum of market capitalization, long-term debt and short term capital structure divided by total assets (Lewellen and Badrinath, 1997;Aivazian et al, 2005;Rountree et al, 2008) -Market to Book ratio calculated as the ratio of market capitalization divided by shareholders' equity.…”

“…Hypothesis 1: debt affects positively or negatively firm value. (2004), Cheng (2008), Rountree et al (2008) and Nuryaman (2015), we estimate profitability by the ratio of net income divided by total assets. Profitability is a measure of firm performance.…”

“…Firm size: similar to Cui and Mak, (2002), Connolly and Hirschey (2005), Rountree et al (2008), Cheng (2008), Levitas and Chi (2010) and Miller (2004), we estimate firm size by the logarithm of total assets. Agrawal Knoeber (1996) suggest for a negative interdependence between firm size and firm value.…”

Do Investors Value Cash Flow Stability of Listed Infrastructure Funds?

“…Lang et al (2003a), Badrinath et al (1989) or Trueman and Titman (1988)). In particular, Rountree et al (2008) show for a sample of US listed firms that earnings smoothness is associated with superior firm valuation. Also if decomposing earnings, they show that smoothness of the cash flow as well as the accruals component of earnings positively affects firm value measured based on Tobin's q.…”