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Review of Accounting Studies

Erschienen in:

01.06.2014

The quality of street cash flow from operations

verfasst von: Nerissa C. Brown, Theodore E. Christensen

Erschienen in: Review of Accounting Studies | Ausgabe 2/2014

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Abstract

We provide empirical evidence on the quality of street cash flow from operations (CFO) as an alternative financial performance summary measure. We focus our investigation on the quality of the items analysts exclude in their determination of street CFO. Based on a sample of 8,518 firm-year observations over the 1993–2008 period, we find that the street CFO number is generally higher than the GAAP CFO number, indicating that analysts typically make CFO-increasing exclusions. Our inspection of hand-collected analyst reports reveals that, while some analysts make sophisticated exclusions of transitory cash items, many others ignore working capital and other accruals when adjusting forecasted earnings to arrive at their street CFO forecasts. We find that street CFO exclusions are negatively associated with future operating earnings, suggesting that these exclusions are not fully transitory or unimportant in forecasting future performance. Our results also indicate that street CFO exclusions are less transitory than the implicit accrual component of analysts’ street earnings exclusions. These results suggest that the average quality of analysts’ street CFO exclusions is quite low and that it is even lower than the quality of their implied accrual exclusions. Moreover, we find that investors perceive analysts’ CFO exclusions to be of such low quality to render street CFO measures less informative than GAAP CFO figures. Finally, we find that analyst conflicts of interest and (to some extent) the greater inherent volatility of firms’ CFO series contribute to the low-quality nature of analysts’ street CFO exclusions.

Vorheriger Artikel Why do managers avoid EPS dilution? Evidence from debt–equity choice

Nächster Artikel Short-term earnings guidance and accrual-based earnings management

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We base our large-sample analyses on the I/B/E/S actual CFO metric (an ex post FDP-adjusted measure based on analysts’ ex ante forecasts). Our small-sample analyses are based directly on hand-collected data from analysts’ ex ante reports. We acknowledge that we often discuss “analysts’ exclusions” even though the actual CFO measure is determined ex post by I/B/E/S using the majority rule (based on ex ante exclusions from analysts’ CFO forecasts).

Prior research also suggests an increase in voluntary disclosures of management CFO forecasts (especially adjusted CFO forecasts) and that this trend is fueled by investor demand (Wasley and Wu 2006; Dambra et al. 2013).

Consistent with this line of research, we use the term “sophistication” to refer to the quality of analysts’ derivation of their street CFO forecasts. Sophisticated forecasts are those derived from detailed predictions of working capital accruals and other non-cash add-backs to forecasted earnings, whereas less-sophisticated (or naïve) forecasts are those derived by simply adding back predictions of depreciation expense to the forecasted earnings figure.

Similarly, Pae et al. (2007) find that analysts experience an improvement in earnings forecast accuracy when they issue CFO forecasts. However, they find that the indirect benefit of CFO forecasts on earnings forecast accuracy is limited in that CFO forecast issuers do not outperform the earnings forecast accuracy of non-issuers.

The quality of analyst street metrics may change over time due to several factors including regulatory intervention, procedural and definitional changes undertaken by FDPs, changes in accounting standards over time, and other time trend effects. We address the potential influence of these time-related factors in our empirical tests to follow.

EPS _GAAP-OP and EPS _GAAP-BXI are the applicable basic or diluted per share figure matched to the I/B/E/S definition. We compute CFO _GAAP-COP as follows: we begin with Compustat’s cash flow from operations (annual data item OANCF) and subtract the cash portion of extraordinary items and discontinued operations (annual data item XIDOC). We then divide this value by the number of common shares used to calculate basic EPS (annual data item CSHPRI) if the I/B/E/S figures are reported on a primary share basis. If the I/B/E/S figures are reported on a diluted share basis, we multiply the cash flow value by the inverse of the ratio of basic EPS to diluted EPS, both before extraordinary items and discontinued operations (annual data item EPSPX ÷ data item EPSFX), or the inverse of the dilution factor reported in I/B/E/S if data item EPSPX or EPSFX is missing or equal to zero.

We find similar evidence when we define future operating performance as one-year-ahead GAAP CFO per share or one-year-ahead street earnings or street CFO per share.

In robustness tests, we find similar results when we use the raw values of SDC/SDE rather than the HI_SDC/SDE indicator variable. Thus, our results are not sensitive to the use of the top quintile threshold.

We thank Jay Ritter for sharing the modified Carter-Manaster reputation rankings (available at http://bear.warrington.ufl.edu/ritter/ipodata.htm).

We compute total assets per share by scaling total assets with the applicable number of common or diluted shares used to calculate basic or diluted EPS as matched to the I/B/E/S/definition (see footnote 6 for further details).

We obtained the Broker Translation File from I/B/E/S in 2005. For firm-years after 2005, we supplement our identification of brokerage/research firm names using the I/B/E/S recommendation detail file, which include analyst names and abbreviated broker names (see Bradshaw et al. 2012 for a similar approach).

This approach is consistent with Givoly et al. (2009), who find some improvement in analysts’ incorporation of working capital and other accruals into their CFO forecasts over the fiscal year. To validate our approach, we inspect the reports of a small subset of analysts issuing multiple CFO forecasts for the same firm-year. We observe that some analysts do not incorporate certain accruals when deriving early-year CFO forecasts but begin to include them in later-year forecasts. From these reports, it appears that some analysts begin to incorporate these items after firms either release an earnings report or provide management forecast guidance. This anecdotal evidence is consistent with Christensen et al. (2011), who find that analysts’ computation of street earnings is influenced by management earnings guidance.

Of the 110 reports, about 87 % cover the 2004–2008 period. This data sampling reflects (1) a large number of missing reports in Investext prior to 2004 and (2) the higher frequency of CFO forecasts for each firm in later years.

In some cases, we refer to the analyst’s computation of actual CFO for the prior fiscal year along with the firm’s prior-year cash flow statement to help identify the items excluded from the analyst’s current-year CFO forecast.

Yoo et al. (2011) list seven CFO definitions commonly used by analysts. Five of these definitions distinctly exclude changes in working capital accruals as an adjustment to forecasted net income.

For example, the 2004 CIBC World Markets analyst report for Exxon Mobil defines street CFO as forecasted CFO plus gains on asset sales and dispositions.

See Black and Christensen (2009) for a similar approach in assessing the average magnitude and statistical significance of the items excluded from manager-adjusted pro forma earnings.

Our results are unchanged if we do not winsorize these variables at the 1 and 99 % levels.

Consistent with practitioners’ recommendations, this result could partly reflect the exclusion of tax benefits and payments arising from nonrecurring transactions (see e.g., Fink 2002; Mulford and Comiskey 2005).

In robustness tests, we include excess tax benefits from employee stock options (ESOTAX) as an additional GAAP CFO adjustment. We conduct this analysis for firm-years with non-missing values of ESOTAX as reported in the operating activities section of the cash flow statement. This data item is missing for most of our firm-years prior to 2002, primarily due to changes in accounting for stock options coinciding with the 2001 financial reporting scandals and the 2004 release of FAS 123R. Also, we exclude firm-years in which ESOTAX is reported as a cash flow from financing activities. We do not find a significant association between CFOEXC and ESOTAX, indicating that most analysts do not exclude this tax benefit when forecasting street CFO. Analysts’ failure to exclude this tax benefit from CFO would be considered unsophisticated since prior evidence suggests that ESOTAX is nonrecurring and not relevant for forecasting core CFO performance (Fink 2002; Mulford and Comiskey 2005; Hribar and Nichols 2008).

See Richardson et al. (2005) for a similar specification of the relative persistence of accruals and cash flows.

In robustness tests, we find similar results when we use Eq. 4 to estimate our results.

In robustness tests, we continue to find a significantly negative coefficient on CFOEXC when we control for the differential persistence of the recurring and special items components of analysts’ street earnings exclusions.

In unreported results, we do not find a significant difference in investors’ reaction to EARNEXC and CFOEXC following SEC scrutiny into the use of non-GAAP financial metrics. This result suggests that investors do not perceive street CFO exclusions to be of higher quality following SEC scrutiny, despite post-intervention improvements in the transitory nature of these exclusions.

In untabulated results, we find that the magnitude of analysts’ street CFO exclusions is positively associated with both TOPTIER and HI_SDC/SDE. This result suggests that strongly conflicted analysts and analysts following firms with high CFO volatility tend to make larger CFO-increasing exclusions when deriving the street CFO metric.

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Titel: The quality of street cash flow from operations
verfasst von: Nerissa C. Brown
Theodore E. Christensen
Publikationsdatum: 01.06.2014
Verlag: Springer US
Erschienen in: Review of Accounting Studies / Ausgabe 2/2014
Print ISSN: 1380-6653
Elektronische ISSN: 1573-7136
DOI: https://doi.org/10.1007/s11142-014-9276-9

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