Disappearing Investment-Cash Flow Sensitivities: Earnings Have Not Become a Worse Proxy for Cash Flow

33 Pages Posted: 22 Dec 2016 Last revised: 16 Jan 2017

See all articles by Niclas Andrén

Niclas Andrén

Lund University - Department of Business Administration

Håkan Jankensgård

Lund University - Department of Business Administration; Knut Wicksell Centre for Financial Studies

Date Written: December 12, 2016

Abstract

According to a recent conjecture in the literature, earnings have become a poorer proxy for cash flow from operations over time. We find that since 1988, when cash flow statements started to be consistently reported in Compustat, the cash effectiveness of earnings has actually increased for a large sample of US manufacturing firms. This occurs despite the introduction of fair value accounting and increasing accounting accruals during the last three decades. The evidence suggests that this puzzle is explained by more efficient working capital management. Also contrary to the conjecture, using more comprehensive measures of cash flow does not restore the investment-cash flow sensitivity, which continues to be around 0.05 in more recent periods. We end by noting that the investment model used in the literature can be enhanced by including accruals, since it leads to a more precise estimation of cash flow.

Suggested Citation

Andrén, Niclas and Jankensgård, Håkan, Disappearing Investment-Cash Flow Sensitivities: Earnings Have Not Become a Worse Proxy for Cash Flow (December 12, 2016). Available at SSRN: https://ssrn.com/abstract=2887729 or http://dx.doi.org/10.2139/ssrn.2887729

Niclas Andrén

Lund University - Department of Business Administration ( email )

Box 117
SE-221 00 Lund, S-220 07
Sweden

Håkan Jankensgård (Contact Author)

Lund University - Department of Business Administration ( email )

Box 117
SE-221 00 Lund, S-220 07
Sweden

Knut Wicksell Centre for Financial Studies ( email )

Box 7080
Lund, SE-220 07
Sweden

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