eijmms title may 2012

198 Pages·2012·3.76 MB·English

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EXCEL International Journal of Multidisciplinary Management Studies
Vol.2 Issue 5, May 2012, ISSN 2249 8834
Online available at http://zenithresearch.org.in/

EXCEL INTERNATIONAL JOURNAL OF MULTIDISCIPLINARY MANAGEMENT STUDIES
(EIJMMS)
VOL. 2 - ISSUE 5; MAY 2012

S.NO. CONTENTS PAGE
INCREMENTAL INFORMATION CONTENT OF CASH FLOWS VERSUS FUNDS
FROM OPERATIONS AND EARNINGS: APPLYING NEW METHODOLOGIES IN
1. FRENCH CONTEXT 1-13

KHALID ELOUAFA
A STUDY ON CUSTOMERS’ SATISFACTION TOWARDS BSNL LANDLINE
SERVICES IN SALEM CITY, TAMIL NADU
2. 14-28

M.GURUSAMY, A.VELSAMY, DR.N.RAJASEKAR
IMPORTANCE TO MAINTAIN A LEVEL OF SECRECY IN CORPORATE SECTOR
IN THE BACKGROUND OF ARTHASASTRA
3. 29-36

SMT. DEBASHREE MAHAPATRA, DR. SANJIT KUMAR DAS
BRAND IMAGE, CUSTOMER SATISFACTION AND LOYALTY INTENTION:
A STUDY IN THE CONTEXT OF COSMETIC PRODUCT AMONG THE PEOPLE
4. OF CENTRAL INDIA 37-50

SATENDRA THAKUR, DR. A. P SINGH
CAPITALISM v. NEO CAPITALISM A COMPARISON OF POLICIES OF WORLD
BANK AND RBI
5. 51-63

DR. SHOBHALATA V. UDAPUDI, BARNIK GHOSH
DIVERSIFICATION - STRATEGIES FOR MANAGING A BUSINESS
6. 64-73
P. KANNAN, DR. R.SARAVANAN
EMERGENCE OF CORPORATE GOVERNANCE IN INDIA
7. 74-90
C.UDAYA KUMAR RAJU, M. SUBRAMANYAM, HIMACHALAM DASARAJU
SOCIAL MEDIA MARKETING IN INDIA – CREATING NEW GROUNDWORK IN
MARKETING INNOVATION
8. 91-99

KHUSHBU PANDYA

CORPORATE GOVERNANCE IN INDIA: EVOLUTION AND CHALLENGES n
9. 100-119 i
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DR. ANSHUL SHARMA, MS. POOJA GUPTA r
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GLOBALIZATION & NEW POLITICAL-CULTURAL IDENTITY .h
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10. 120-131 r
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RAHMAT ABBASTABAR MOGHRI, G.T.RAMACHANDRAPPA e
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100% FDI IN SINGLE-BRAND RETAIL OF INDIA- A BOON OR A BANE? e
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11. 132-146 t
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J.J.SOUNDARARAJ e
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TRAINING NEEDS IDENTIFICATION OF NURSING STAFF – A CASE STUDY OF .w
A HEALTH CARE ORGANIZATION w
12. 147-153 w

DR. V.RAMA DEVI, M.MALLIKA RAO
EXCEL International Journal of Multidisciplinary Management Studies
Vol.2 Issue 5, May 2012, ISSN 2249 8834
Online available at http://zenithresearch.org.in/

AN EXPLORATORY STUDY ON MEASURING IMPACT OF INTERNET ON
STUDENTS’ ACADEMIC LIFE OF S.P. UNIVERSITY
13. 154-167

RINA DAVE
GREEN PRODUCT LIFE CYCLE TO CALCULATE THE GROSS DOMESTIC
PRODUCT POLLUTION OF A COUNTRY
14. 168-172

S. RAJASHEKHAR
INCLUSIVE ECONOMIC GROWTH IN INDIA: ISSUES AND CHALLENGES
15. 173-183
MR.CH.PRASHANTH, DR.G.SHASHIDHAR RAO
GREEN MARKETING
16. 184-195
MRS. FATI SHAFAAT, ARIF SULTAN

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EXCEL International Journal of Multidisciplinary Management Studies
Vol.2 Issue 5, May 2012, ISSN 2249 8834
Online available at http://zenithresearch.org.in/

INCREMENTAL INFORMATION CONTENT OF CASH FLOWS VERSUS
FUNDS FROM OPERATIONS AND EARNINGS:
APPLYING NEW METHODOLOGIES IN FRENCH CONTEXT

KHALID ELOUAFA*

*Assistant Professor,
Cadi Ayyad University,
Marrakesh, Morroco.

ABSTRACT

The purpose of our study is to examine the information content of cash flows versus funds from
operations and earnings in the French context. By applying two methodologies relating to linear
and nonlinear models, our work analyzes the capacity of these accounting measures to explain
stock returns of French listed companies in the SBF120 index. Our results relating to linear
models show that cash flows and funds from operations have incremental information content
while nonlinear models note that these accounting measures have incremental information
content only in the case of extreme variations. In addition, the results note that earnings have
incremental information content in the case of moderate variations. One can infer that market
participants in French context use and appreciate information contained in cash flows to evaluate
firms’ performances especially when they show extremes variations.

KEYWORDS: Incremental information content, cash flows, funds from operations, earnings,
stock returns, French companies.
______________________________________________________________________________

INTRODUCTION
During the last two decades, one witness a growing interest of researchers to information
contained in cash flows, funds from operations and earning. However, this topic in France is not
widely considered by researchers. The studies relating to information content are retrospective

and are based on efficiency hypothesis, i.e. the stocks prices reflect all information available on
the market. Generally, there are two forms of studies: 1/ reaction studies, they are based on short
n
event windows (for example, 8 days until one month) and measure the market reaction following i
.g
the disclosure of accounting information and 2/ association studies, they are based on long term r
o
windows (for example, one quarter or one year) and calculate the degree of correlation between .h
c
stock returns and accounting measurements. ra
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s
e
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Prior studies concerning information content of cash flows have assumed a linear relationship h
t
i
between this accounting measurement and stock returns and did not document conclusive results n
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about the presence of incremental information content in cash flows (Rayburn, 1986; Bowen, .w
Burgstahler and Daley, 1987; Wilson, 1986, 1987 et Bernard and Stober, 1989).However, the w
w
recent studies have taken the presence of transitory components into account and have assumed a

non linear relation between accounting information and stock returns (Freeman and Tsee, 1992;

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EXCEL International Journal of Multidisciplinary Management Studies
Vol.2 Issue 5, May 2012, ISSN 2249 8834
Online available at http://zenithresearch.org.in/

Ali and Zarowin, 1992; Ali, 1994; Cheng and al., 1996); they note the presence of incremental
information content for cash flows especially in the case of moderate variations.
Our results confirm those documented in several studies applying the control of extreme
variations; thus, earnings have incremental information content only when they show moderate
variations. However, the cash flows and funds from operations show a similar behaviour, they
have incremental information content only when they have extremes variations.
The rest of this paper is organized as follows: section 2 presents hypothesis. Section 3 discusses
linear models. Section 5 presents variable definitions, sample selection and descriptive statistics.
Section 6 shows results relating to linear models. Section 7 describes non linear models. Section
8 shows results concerning non linear models. Section 9 concludes the paper.
1. HYPOTHESIS
One of the major concerns of investors is the appreciation of the firm’s capacity to generate cash
flows in order to face its own exploitation, investment and financing needs, and to remunerate
shareholders by taking into account risk rate of equity which is placed in firm’s capital. In
addition, the investors placed on the market seek for any useful information which enables them
to form and adjust their anticipations; so the cash flows information shows advantage that is not
affected by accounting conventions compared to other accounting measurements based on
accruals (earnings and funds from operations). Therefore, I assume that information contained in
cash flows is in eyes of investors relevant to form and adjust theirs anticipations. Moreover, this
information is differently assessed by investors compared to that contained in the net income or
funds from operations. Consequently, one expect a positive relation between the change of cash
flows and abnormal returns.
H1: Cash flow from operations likely has incremental information content beyond that contained
in earnings or funds from operations.
H2: The information contained in cash flow from operation is likely to be differently assessed by
investors compared to information contained in earnings or funds from operations.

Incremental information content of cash flows, funds from operations and earnings: application

of linear models
n
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Prior studies on incremental information content of cash flows, funds from operations and r
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earnings are generally applying linear models (Rayburn, 1986; Bowen, Burgstahler and Daley, .h
c
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1987; Wilson, 1986, 1987 et Bernard and Stober, 1989) and show incremental information a
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content of accounting measurements based on accruals –earnings and funds from operations– e
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while they don’t report conclusive results about cash flows measurements. In order to compare t
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the results of prior studies to those of our study, I use the following linear models: e
z
.w
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Model 1: AR a a E a CFO u
it 0 1t it 2t it it w

Model 2: AR b b E b FFO u
it 0t 1t it 2t it it

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EXCEL International Journal of Multidisciplinary Management Studies
Vol.2 Issue 5, May 2012, ISSN 2249 8834
Online available at http://zenithresearch.org.in/

Model 3: AR c c FFO c CFO u
it 0t 1t it 2t it it
Where AR is the abnormal stock returns of firm i in period t (beginning in the April of year N-1
it
and ending in the March of year N), its calculation is presented below; ΔE is change in
it
earnings; ΔCFO is change in cash flow from operations and ΔFFO is change in funds from
it it
operations. All variables are deflated by beginning-of-period market value of equity.
The abnormal returns are defined as follows:
ARit= Rit – Rmt
Where R is the cumulated returns of firm i in period t (from April of fiscal year N-1 to March of
it
n
fiscal year N), it’s estimated from monthly returns (R ): R (1 R ) 1; and R
im it im Mt
m 0
represents the index market return in period t.
2. VARIABLE DEFINITIONS, SAMPLE SELECTION AND DESCRIPTIVE
STATISTICS
Accounting variables (earnings, funds from operations, cash flow from operations) are gathered
from annual financial statements disclosed in annual reports for [2000-2006] period, because in
France the imposition of cash flow statements disclosure came into force in 2000. The annual
reports are downloadable on the site of the Authority of Financial Market (AMF) or from
companies’ web sites. Earnings are defined as income before extraordinary items; funds from
operations correspond to operating profit before working capital changes; and cash flows are
defined as net cash flow from operating activities. On the other hand, stock exchange
information (stock price, dividend and returns) is obtained from database DataStream for the
period [2000-2006].
Our sample consists of French companies listed on the SBF120 index of Euronext Paris
exchange. Because of their accounting specificities, the financial companies are excluded from
the sample as well as the observations whose absolute value of their change is higher than 1.
Moreover, I eliminate all companies whose fiscal years are not closed at 31 December. Thus, I

obtain 436 annual observations corresponding to 75 companies for the period [2000-2006]

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(Insert table 1 here). .g
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The descriptive statistics in table (2) point out that the average of earnings (0,0728) is lower than c
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that of funds from operations (0,1980) and cash flows from operations (0,1894) –given that all e
s
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explanatory variables are deflated by beginning-of-period market value of equity. This result can r
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be explained by the fact that earnings include short and long term accruals which generally ti
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decrease their values. The table (1) also shows that standard deviation of cash flows (0,5560) is ez
.w
higher than that of earnings (0,4894). This result confirm those noted by Dechow (1994) and
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Dechow et al. (1998), assuming that by accruals earnings are less volatiles than cash flows. w

However, accruals can be used by managers to convey their own information and offer them an

opportunity to manipulate accounting measures. In addition, the averages of three accountings

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EXCEL International Journal of Multidisciplinary Management Studies
Vol.2 Issue 5, May 2012, ISSN 2249 8834
Online available at http://zenithresearch.org.in/

measures present values close to their last quartiles, (0,0728) versus (0,0863) for earnings;
(0,1980) versus (0,1907) for funds from operations; and (0,1894) versus (0,1829) for cash flows
from operations; this means that almost 75% of our observations are lower than the average of
their distribution and almost 25% are higher than the average of their distribution. Thus, the
presence of high variations seems inevitable and can affect the robustness of our linear
regressions (Easton and Harris, 1991; Ali and Zarowin, 1992; Ali, 1994; Cheng and Yang,
2003..).
In addition, the bilateral correlation analysis between abnormal returns and explanatory variables
(table 3) shows a positive and not statistically significant correlation for changes in cash flows
(0,098) and changes in funds from operations (0,093) at 0,01 level. However there is a negative
and not statistically significant relationship between changes in earnings and abnormal returns. It
can also be seen that there are positives and statistically significant relationships between
independent variables but they are not so strong to compromise our regressions by causing
multicollineraty problem.
(Insert table 3 here)
3. REGRESSION RESULTS OF LINEAR MODELS
Prior works on the incremental information content of earnings, funds from operations and cash
flows commonly apply linear models and note a presence of incremental information content for
accounting measures based on accruals while they don’t report a conclusive result for cash flows
measures. In the same way, I estimate in the French context the linear models provide both a
basis for comparing my results with those of prior studies and a benchmark for comparing the
results of the non linear model used in this study. Following prior studies, I use changes in
earnings, funds from operations, and cash flows as measures of their unexpected values to obtain
the following models:
Model 1: AR a a E a CFO u
it 0t 1t it 2t it it
Model 2: AR b b E b FFO u
it 0t 1t it 2t it it

Model 3: AR c c FFO c CFO u
it 0t 1t it 2t it it n
i
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I consider only changes in accounting measures because they allow to better capture their r
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behaviours, especially in the case of presence of permanent component into variables. Thus, I .h
c
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assume implicitly that the three variables are only composed by permanent component. a
e
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However, in the case of dominance of transitory component into variables, it is their value which e
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permits to capture their behaviours rather then their change (Easton and Harris, 1991; Ohlson, t
i
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1989; Ali and Zarowin, 1992a and Cheng and Yang 2003). e
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Table (4) reports the regression estimates of models 1, 2 and 3. The results relating to model (1) w
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show as expected that cash flows have incremental information content beyond earnings. Thus,

one can deduce that change in cash flows can explain the price changes that are assumed to
reflect market anticipations. In addition, the coefficients equality tests point out that the null

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EXCEL International Journal of Multidisciplinary Management Studies
Vol.2 Issue 5, May 2012, ISSN 2249 8834
Online available at http://zenithresearch.org.in/

hypothesis can be rejected at 5% level. Consequently, the investors placed on the market assess
differently the information contained in cash flows compared to that contained in earnings.
However, and contrary to the prior studies, our results show the earnings don’t have incremental
information content beyond cash flows.
The estimate of regression (2) confirms that funds from operations as well as cash flows have
incremental information content beyond earnings, they show a positive and statistically
significant coefficient 0,263 (2,027). On the other hand, earnings don’t have incremental
information content beyond funds from operations. In addition, the test of coefficients equality
(table 5) confirms that the information contained in funds from operations can be differently
assessed by investors comparing to information contained in earnings. Thus, one can suggest that
investors appreciate and have a great interest in information contained in funds from operations.
On the other hands, the estimation of regression (3) does not confirm a presence of incremental
information content for cash flows as well as funds from operations. Moreover, the Wald test can
not reject the null hypothesis so one conclude that investors do not assess differently the
information contained respectively in theses two accounting measures.
From the estimates of the linear regressions presented above one can conclude that cash flows
and funds from operations show a similar behaviour so they have incremental information
content beyond earnings. Moreover, the information contained in each measure is differently
assed by participants on the market compared to that contained in earnings. On the other hand,
earnings do not have incremental information content beyond cash flows or funds from
operations. This result can be explained both by the fact that information about earnings of big
companies can be provided to the market by several channels (interim reporting, financial
news..) or by the effect of presence of the transitory component in earnings measure. In addition,
cash flows and funds from operation do not show incremental information content and they not
differently assessed by investors on the market. Nevertheless, the linear regressions do not take
into account a presence of extreme values in accounting measure; for this reason, one witness the
appearance of news methodologies which milked with the nonlinear model.
4. APPLICATION OF NON LINEAR MODELS

The prior studies on incremental information content of accounting measure are commonly

applied linear models, but this methodology can be relevant only in the case of absence of n
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transitory component in the variables (Brooks and Buckluster, 1976 and Freeman, Ohlson and .g
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Penman, 1982). In other words, the correlations between the abnormal returns and accounting o
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measures might be affected by the presence of extreme variations. According to Ali (1994), the c
r
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majorities of former studies adopt linear models and confirm the presence of incremental e
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information content for earnings but not for cash flows. These results reflect the relation between r
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the price changes and transitory component in earnings rather than its permanent component, and ti
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thus they are not conclusive. In order to consider the presence of transitory components in z
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accounting measures, the new methodologies are implemented; they concern the application of
w
non linear models (Freeman and Tsee, 1992; Ali, 1994; Cheng et al, 1996 and Cheng and Yang w

2004). These models allow noting that the marginal reaction of stock prices to change of

accounting measures decrease with the increase in the absolute value of this change.

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EXCEL International Journal of Multidisciplinary Management Studies
Vol.2 Issue 5, May 2012, ISSN 2249 8834
Online available at http://zenithresearch.org.in/

The application of nonlinear models implies the consideration of the magnitude of change in
accounting measures and their tendency (transitory or permanent). Following Ali (1994) and
Cheng and Yang (2003), I classify the variables (earnings, cash flows and funds from operation)
to two groups: 1- group of extreme change or high group (the absolute value of variable change
is higher than its median); 2- group of low change or low group (the absolute value of variable
change is lower than its median).
Because of the significant level of correlation between cash flows and funds from operation, I
limit our analyse to, firstly, information content of cash flows versus earnings and, secondly, to
information content of funds from operations versus earnings. Thus, I estimate the nonlinear
models as follows:
Models 4: AR a a E a E *DE a CFO a CFO *DCFO u
it 0t 1t it 2t it 3t it 4t it it
Model 5: AR b b E b E *DE b FFO b FFO *DFFO u
it 0t 1t it 2t it 3t it 4t it it
Where the binary variable DE (DFFO, DCFO) is one when its observation belongs to the high
group and zero in the case of low group. All explanatory variables are deflated by market value
of equity at the beginning of year t.
Following prior works applying new methodologies (Freeman and Tsee, 1992; Ali 1994; Cheng
et al 1996 et Cheng et Yang 2003), I assume that extreme values of accounting measure are
generally transitory and less informative. Thus, the absence of incremental information content
noted for earnings in our linear models might be due to the presence and domination of extremes
values in this measure. Consequently, the cash flows and funds from operation have incremental
information content beyond earnings. In other words, they play a complementary role if the
earnings are less informative; hence, the informational importance of these two accounting
measures.
5. RESULTS RELATING TO NONLINEAR MODELS

THE INCREMENTAL INFORMATION CONTENT OF CASH FLOWS VERSUS

EARNINGS n
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The incremental information content of earnings (cash flows) for the low group and high group o
.h
can be deduced respectively from the coefficients a1 (a3) and the sum of coefficients a1+a2 c
r
a
(a3+a4). The estimate of regression (4) (table 6) shows that the marginal reaction of stock price e
s
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to the earnings change in the high group -6,278 (-1,784) is lower than that concerning low group r
h
6,232 (1,771). However, for cash flows, the marginal reaction of stock price is not significant for ti
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two groups. Moreover, the estimate of nonlinear model point out that its explanatory power is ez
higher than that of linear model (R² adjusted is 0,021 versus 0,012). .w
w
w

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EXCEL International Journal of Multidisciplinary Management Studies
Vol.2 Issue 5, May 2012, ISSN 2249 8834
Online available at http://zenithresearch.org.in/

The incremental information content analysis of cash flows and earnings allows to note that
earnings of low group have incremental information content beyond cash flows a1 = 6,232
(1,771). However, earnings of the high group do not have incremental information content
a1+a2= -0,046 (t = -0,858 = a +a /σ ). On the other hand, cash flows do not show incremental
1 2 a1+a2
information content for the low group a3 = -0,225 (t = -0,123) whereas they have incremental
information content for the high group a +a = 0,207 (t = 7,096).
3 4
These results confirm those noted in previous studies, so earnings are less informative in the case
of extreme values. Therefore, one can suggest that cash flows would have incremental
information content when earnings show extreme values. In other words, the market participants
use and appreciate information contained in cash flows when earnings have extreme and
transitory values.
THE INCREMENTAL INFORMATION CONTENT OF FUNDS FROM OPERATIONS
VERSUS EARNINGS
The incremental information contents of earnings (funds from operations) for low group and
high group can be obtained respectively from the coefficients b1 (b3) and the sum of coefficients
b1 + b2 (b3 + b4). Similarly to the results relative to model (4), the estimate of model (5) (table
7) confirms a weak marginal reaction of the price to the extreme variations of earnings -6,810 (-
1,901) compared to that of low variations 6,751 (1,885). In addition, the explanatory power of
model (5) is higher than that of model (4) and the linear model (2) (adjusted R² =
0,024>0,021>0,013).
From the incremental information content analysis relating to earnings and funds from operations
notes a similarity in funds from operations and cash flows behaviors compared to earnings. Thus,
funds from operations show incremental information content beyond earnings only in the case of
presence of high variations b +b =0,255 (t = 10,851= b +b /σ ). However, for the group of
3 4 3 4 b3+b4
low variations, funds from operations do not have incremental information content beyond
earnings -2,180 (-0,826). Moreover, the earnings have incremental information content for the
low variations group b1 = 6,751 (1,885) and not for the group of high variations b +b = -0,016
1 2
(t= 0,298). Thus, the earnings, contrary to funds from operations, are not informative when it is
the subject of high variations.

By estimating model (5), one conclude that earnings have incremental information content
n
beyond funds from operations only when they represent moderate variations. On the other hand, i.g
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FFO expresses a similar behaviour to cash flows, so they have incremental information content o
.h
beyond earnings only in the case of presence of high variations. These results suggest that c
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investors appreciate the information contained in earnings when they show moderate variations; ae
s
whereas in the case of high variations, it is the funds from operation information which fill the e
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information gap and, consequently, shows incremental information content. t
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e
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To recapitulate, the estimate of nonlinear models note that earnings have incremental .w
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information content beyond cash flows and funds from operation only when they show moderate
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variations. However, cash flows and funds from operations have incremental information content

beyond earnings only when they have extreme variations. Moreover, cash flows and funds from

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