Changes in Cash: Persistence and Pricing Implications

50 Pages Posted: 19 Feb 2014

See all articles by Jeff Zeyun Chen

Jeff Zeyun Chen

Texas Christian University

Philip B. Shane

College of William & Mary - Raymond A. Mason School of Business

Multiple version iconThere are 2 versions of this paper

Date Written: February 18, 2014


This paper decomposes the cash component of earnings and analyzes persistence characteristics and pricing implications of various subcomponents, with particular attention on changes in cash. Changes in underlying fundamentals might dictate changes in cash to new optimal levels. Alternatively, suboptimal changes in cash might result from agency costs allowing managers’ actions to diverge from the best interests of shareholders. We predict and find that both suboptimal increases and decreases in cash bode poorly for future earnings. In fact, we find that suboptimal increases (decreases) in cash have less (greater) persistence than any of the earnings components we study, including accruals and net distributions to both shareholders and debt holders. Market efficiency tests indicate that the market severely punishes firms with suboptimal decreases in cash, but we find no evidence to support the hubris hypothesis that the market overreacts to the earnings implications of unwarranted increases in cash.

Keywords: Earnings persistence; Free cash flow; Fundamentals-driven changes in cash, Suboptimal cash build-up, Suboptimal cash reduction; Market efficiency with respect to changes in cash

JEL Classification: M41, G14

Suggested Citation

Chen, Jeff Zeyun and Shane, Philip B., Changes in Cash: Persistence and Pricing Implications (February 18, 2014). Available at SSRN: or

Jeff Zeyun Chen (Contact Author)

Texas Christian University ( email )

2900 Lubbock Ave
Fort Worth, TX 76109
United States

Philip B. Shane

College of William & Mary - Raymond A. Mason School of Business ( email )

P.O. Box 8795
Williamsburg, VA 23185
United States

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