Auditor Quality Effects on the Relationship between Accruals, Cash Flows and Equity Returns: A Variance Decomposition Analysis

Posted: 23 Apr 2012 Last revised: 21 Apr 2016

See all articles by Mark Clatworthy

Mark Clatworthy

University of Bristol, Department of Accounting and Finance

Christopher K. M. Pong

Heriot-Watt University - School of Management and Languages

Woon K. Wong

IMRU, Cardiff Business School

Date Written: February 1, 2012

Abstract

In this paper, we examine the relative importance of the cash flow and accruals components of earnings in explaining the variation in UK company equity returns, together with the extent to which these relationships vary by auditor quality. We use a multivariate time-series approach that can be reconciled to a log-linear theoretical valuation model and, unlike the standard linear regression of returns on earnings components, accommodates time varying discount rates. Based on a decomposition of the variance of equity returns, cash flows and accruals, our results indicate that both cash flow news and accruals news are important drivers of UK equity returns, although cash flows are more influential than accruals. We also find that variation in both earnings components has a more significant effect on returns for clients of large auditors. Finally, our results provide mixed evidence on the question of whether the impact of auditor quality is highest for the accruals component of earnings.

Keywords: accruals, auditor quality, cash flows, variance decomposition

Suggested Citation

Clatworthy, Mark A. and Pong, Christopher K.M. and Wong, Woon K., Auditor Quality Effects on the Relationship between Accruals, Cash Flows and Equity Returns: A Variance Decomposition Analysis (February 1, 2012). Available at SSRN: https://ssrn.com/abstract=1997483

Mark A. Clatworthy (Contact Author)

University of Bristol, Department of Accounting and Finance ( email )

School of Economics, Finance and Management
8 Woodland Road
Bristol, BS8 1TN
United Kingdom
+44(0)1173310914 (Phone)

Christopher K.M. Pong

Heriot-Watt University - School of Management and Languages ( email )

Edinburgh EH14 4AS, Scotland
United Kingdom

Woon K. Wong

IMRU, Cardiff Business School ( email )

Cardiff CF10 3EU
United Kingdom

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