The Association between Various Earnings and Cash Flow Measures of Firm Performance and Stock Returns: Some Australian Evidence

Abstract

This paper examines the association of various earnings and cash flow based measures of firm performance with stock returns to determine the measure(s) that best capture contemporaneous firm performance. For profit making firms, earnings based performance measures are found to be more closely associated with stock returns than cash flow based measures. This is consistent with accrual accounting enhancing the financial reporting process and providing managers with an efficient mechanism through which their superior information can be signalled to financial statement users, as suggested by Dechow (1994). Similarly for firms with relatively high income increasing accruals, earnings based measures better capture firm performance than cash flow based measures. However, for loss making firms and firms with relatively high levels of income decreasing accruals, neither earnings nor cash flow based measures capture firm performance well.

Keywords: Accounting performance measures, earnings, accruals, cash flows

JEL Classification: G12, M41