In contrast, the non-FLEX subsample’s market-implied persistence of accruals (0.4020) is roughly equivalent (p = 0.6644) to the persistence parameter of accruals (0.4339) in the forecasting equation, while the market-implied persistence of cash flow (0.4039) is lower than the persistence parameter (0.6851), indicating underpricing only of the cash flow component. (Pincus et al. (2007) similarly find underweighting of OCF but not accruals in eight of the countries they study, five of which are European.) Furthermore, the market-implied coefficient of accruals is also roughly equivalent to the market-implied coefficient of cash flow. Overall, these results could be interpreted to suggest that investors value accruals more highly than cash flow-but only for my website the FLEX subsample.
Models of OCF prediction
Table 10 presents regression results for two cash flow prediction models. Footnote 30 Analyses and inferences are based on prediction of OCF as reported on the statement of cash flows, not prediction of real economic OCF, which is unobservable. In panel A, operating cash flows are regressed on prior year’s sales and change in sales. The coefficients on the interaction terms with sales and change in sales are both positive and significant, implying that the classification choices matter when predicting future OCF. The positive sign is consistent with OCF using IFRS classification choice being higher on average that OCF using U.S. GAAP classification choices. The estimated coefficient on sales is positive and significant as expected. However, the coefficient on changes in sales is not significant.
In the past cash flows and accruals models in Table 10, panel B, the FLEX interaction with OCF and accruals is not significant, indicating that the classification choices do not contribute to the prediction of future OCF in this model. This finding is consistent with past OCF and accruals also controlling for the firm’s classification choices. Furthermore, this finding suggests that this type of model may be more useful in the international context in which flexibility in cash flow classification exists.
Our market tests do not provide evidence consistent with the accrual anomaly. Pincus et al. (2007) provide evidence that the accrual anomaly occurs in common law countries and not code law countries. Given that code law countries comprise 12 of the 13 countries in our sample, this finding is consistent. In the United Kingdom, the only common law country in our sample, we also find no evidence of the accrual anomaly. We explore whether the results of our market tests are sensitive to model specification. We find that results of our market pricing analysis in Table 9 are sensitive to model specification. Footnote 31 In particular, when the forecasting and valuation models exclude firm-specific control variables (Size t , BM t , and EP t ), the overall conclusions are similar for both subsamples. These conclusions, based on untabulated results excluding the control variables, are as follows. 1) Accruals are significantly less persistent than operating cash flows as in the base analysis. 2) The market-implied coefficients reflect underpricing of both accruals and operating cash flow as in the base analysis. 3) But the comparative magnitude of the market-implied coefficients shows no indication of the accrual anomaly (i.e., the coefficient on accruals does not exceed the coefficient on operating cash flow), regardless of the firm’s cash-flow classification choice.
Cash flow, and particularly OCF, is used in business valuation and contracting. However, OCF can be measured differently under IFRS and U.S. GAAP because of classification alternatives available only under IFRS. While previous international accounting research focuses on IFRS versus U.S. GAAP differences in earnings and shareholders’ equity, little attention has been given to potential differences in OCF under the two sets of standards.