Surrogate Measures of Operating Cash Flows and Accruals: Problems and Solutions

58 Pages Posted: 28 Nov 2017 Last revised: 21 Mar 2022

See all articles by Ciao-Wei Chen

Ciao-Wei Chen

University of Illinois at Urbana-Champaign - Department of Accountancy

Sam Melessa

University of Iowa - Department of Accounting

Richard Mergenthaler

Penn State University

Heejin Ohn

University of Oklahoma

Date Written: April 1, 2020

Abstract

We examine the implications of measurement error in surrogate measures of operating cash flows. We decompose the measurement error into two components—the inclusion error and the non-articulation error. We find that the measurement error is large in magnitude and primarily driven by the improper inclusion of accruals in surrogate cash flow measures (i.e., the inclusion error). Furthermore, we find the non-articulation error has little effect on the inclusion error. We demonstrate that the measurement error in surrogate cash flow measures produces biased coefficients and incorrect inferences in common research settings. We also provide a simple correction that eliminates the inclusion error and show that the correction reduces biases and improves inferences. Importantly, our decomposition and correction can be used by future researchers to identify, understand, and take steps to mitigate the measurement error and the resulting biases that are introduced when using surrogate measures of operating cash flows.

Keywords: Balance Sheet Method, Surrogate Cash Flow Measures, Surrogate Accruals Measures

JEL Classification: M40, M41

Suggested Citation

Chen, Ciao-Wei and Melessa, Sam and Mergenthaler, Richard Dean and Ohn, Heejin, Surrogate Measures of Operating Cash Flows and Accruals: Problems and Solutions (April 1, 2020). Available at SSRN: https://ssrn.com/abstract=3075461 or http://dx.doi.org/10.2139/ssrn.3075461

Ciao-Wei Chen

University of Illinois at Urbana-Champaign - Department of Accountancy ( email )

1206 South Sixth Street
Champaign, IL 61820
United States

Sam Melessa

University of Iowa - Department of Accounting ( email )

108 Pappajohn Business Building
Iowa City, IA 52242-1000
United States

Richard Dean Mergenthaler (Contact Author)

Penn State University ( email )

University Park, PA 16802-3306
United States

Heejin Ohn

University of Oklahoma ( email )

Michael F. Price College of Business
307 W Brooks, AH200F
Norman, OK 73019-4004
United States
(405) 325-5780 (Phone)

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