Informativeness And Predictability Of Cash Flows

Abstract

This study investigates the relationship between the informativeness and the predictability of cash flow data. Predictability is defined as the ability of an accounting variable to predict future cash flows. Using a two-signal capital asset pricing model, this study predicts that the incremental informativeness of cash flows is an increasing function of its predictability and a decreasing function of the predictability of earnings. The empirical evidence is consistent with this prediction. This study contributes to the cash flow/earnings literature in that it identifies a context in which cash flow data possess significant incremental information content beyond that reflected in earnings. The research findings of this study also have methodological implications for other incremental information content studies. Specifically, it suggests that the informativeness of alternative information is an important factor in examining the incremental information of an accounting variable.