The Value Relevance of Earnings and the Prediction of One-Year-Ahead Cash Flows

29 Pages Posted: 13 Sep 2007

See all articles by Oliver Kim

Oliver Kim

University of Maryland

Steve C. Lim

Texas Christian University - M.J. Neeley School of Business

Taewoo Park

Kennesaw State University

Date Written: September 11, 2007

Abstract

In this paper we examine the validity of using one-year-ahead cash flows prediction tests as a substitute for the value relevance test of earnings. We show theoretically that the R2 of the cash flows prediction regression is contaminated by the presence of (1) noise in the cash flows and (2) spurious, i.e., value-unrelated, correlation between one-year-ahead cash flows and current earnings. We test if either of the above two factors contribute to the result of Kim and Kross (2005) that the ability of earnings to predict one-year-ahead cash flows has increased over the recent decades, in contrast to the evidence of decreasing value relevance of earnings. We find empirical evidence that both factors contributed to their result and conclude that the cash flows prediction test is a poor substitute for the value relevance test of earnings.

Keywords: value relevance of earnings, prediction of one-year-ahead cash flows

JEL Classification: G12, M41

Suggested Citation

Kim, Oliver and Lim, Steve and Park, Taewoo, The Value Relevance of Earnings and the Prediction of One-Year-Ahead Cash Flows (September 11, 2007). Available at SSRN: https://ssrn.com/abstract=1014185 or http://dx.doi.org/10.2139/ssrn.1014185

Oliver Kim

University of Maryland ( email )

Rm.4449, Van Munching Hall
College Park, MD 20742-1815
United States
301-405-2243 (Phone)

Steve Lim (Contact Author)

Texas Christian University - M.J. Neeley School of Business ( email )

2900 Lubbock Street
Fort Worth, TX 76129
United States
817-257-7536 (Phone)

Taewoo Park

Kennesaw State University ( email )

1000 Chastain Rd
Kennesaw, GA 30144
United States

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