Accounting - Theses
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ItemMeeting or beating cash flow forecasts: market response, future performance and real activities management( 2011)Analysts’ cash flow forecasts are not new to the market. However, academic research interest in them is relatively new. Recent studies investigating cash flow forecasts show that these forecasts can affect positively the quality of accruals (McInnis and Collins, 2011) and the accuracy of earnings forecasts (Call et al, 2009). Other studies argue that these forecasts can also have market implications (DeFond and Hung, 2003). They document that the market responds positively to meeting or beating cash flow forecasts (Melendez et al, 2005, Zhang, 2008, Brown and Pinello, 2008). This thesis builds on prior research by (1) addressing the association between meeting or beating cash flow forecasts and future operating performance, (2) analyzing the market response to firms meeting or beating cash flow forecasts using real activities management, (3) studying future market returns and operating performance for companies meeting or beating cash flow forecasts using real activities management, and (4) investigating the market response to meeting or beating cash flow forecasts vis-à-vis the market response to meeting or beating accruals forecasts in contexts related to high levels of accruals, capital intensity, poor financial health and change in institutional settings. Using quarterly data, empirical findings from this thesis confirm prior research results that the market responds positively to meeting or beating cash flow forecasts. This provides evidence that the market reward to meeting or beating cash flow forecasts exists for shorter reporting periods, which further supports the argument that meeting or beating cash flow forecasts provides value relevant information to market participants With regard to the association between meeting or beating cash flow forecasts and future performance, regression results show that subsequent period operating performance is higher for firms meeting or beating cash flow forecasts than for firms missing cash flow forecasts. This finding suggests that meeting or beating cash flow forecasts conveys positive information about future performance, which can explain the positive market response to this event. In relation to the use of real activities management by firms meeting or beating cash flow forecasts, empirical results show that the market responds positively to firms meeting or beating cash flow forecast using real activities management. The results further suggest that using real activities management does not affect negatively the market response to meeting or beating cash flow forecasts. These results are consistent with market’s inability to detect real activities management even in contexts where companies have a strong motivation to engage in these decisions like the cash flow forecasts context. This may explain why companies that meet or beat cash flow forecasts opt to use these methods. Furthermore, empirical findings show that subsequent quarter’s operating performance is lower for firms using real activities management to meet or beat cash flow forecasts. However, the results from future returns models do not provide conclusive evidence on these returns reflecting the negative future performance implications of real activities management. This implies that market participants are unable to process the future negative implications of, or reverse the contemporaneous response to, the use of real activities management to meet or beat cash flow forecasts even after they have been realized. In relation to the effect of contextual factors on the market response to meeting or beating cash flow forecasts, empirical findings show that changes in institutional settings in the aftermath of accounting scandals increased the market response to meeting or beating cash flow forecasts, while other contexts like capital intensity, accruals, and financial health do not have significant effects on that market response. The increase in the market response reflects higher emphasis by market participants on cash flow information after the enactment of regulatory changes following high profile bankruptcies in the early 2000s. Finally, in relation to the effect of contextual factors on the difference in market response to meeting or beating cash flow forecasts and accruals forecasts, regression results suggest that the market response to meeting or beating cash flow forecasts exceeds that to meeting or beating accruals forecasts. The difference is higher in settings where cash flow information is perceived to be more useful than accruals information. This result is consistent with prior research findings that the relative advantage of cash flows over accruals is context specific. These findings can have implications in relation to issues relating to market rationality, the role of contexts in relation to accounting information and the consequences of corporate decisions, which will contribute to various streams of the accounting literature like the analysts’ forecasts, earnings management, capital market and information content literatures.