IDEAS home Printed from https://ideas.repec.org/a/bla/acctfi/v60y2020is1p877-908.html
   My bibliography  Save this article

The importance of cash flow disclosure and cost of capital

Author

Listed:
  • Richard Anthony Kent
  • Di Bu

Abstract

We examine whether the choice of cash flow disclosure under International Accounting Standard 7 has an influence on the cost of capital incurred by Australian listed companies. Results indicate that indirect method companies incur a significantly higher ex‐ante cost of equity than direct method companies using a combined equity model approach. We also demonstrate that using an optimal weighted combination of equity models reduces model variance and bias compared to using a single equity model. Our findings support mandating the direct method and have the potential to induce companies to report the direct method to increase company value.

Suggested Citation

  • Richard Anthony Kent & Di Bu, 2020. "The importance of cash flow disclosure and cost of capital," Accounting and Finance, Accounting and Finance Association of Australia and New Zealand, vol. 60(S1), pages 877-908, April.
    • Handle: RePEc:bla:acctfi:v:60:y:2020:i:s1:p:877-908
    DOI: 10.1111/acfi.12382
    as

    Download full text from publisher

    File URL: https://doi.org/10.1111/acfi.12382
    Download Restriction: no
    File URL: https://libkey.io/10.1111/acfi.12382?utm_source=ideas
    LibKey link: if access is restricted and if your library uses this service, LibKey will redirect you to where you can use your library subscription to access this item
    ---><---

    References listed on IDEAS

    as
    1. Francis, Jennifer & LaFond, Ryan & Olsson, Per & Schipper, Katherine, 2005. "The market pricing of accruals quality," Journal of Accounting and Economics, Elsevier, vol. 39(2), pages 295-327, June.
    2. Carhart, Mark M, 1997. "On Persistence in Mutual Fund Performance," Journal of Finance, American Finance Association, vol. 52(1), pages 57-82, March.
    3. Paul M. Healy & Amy P. Hutton & Krishna G. Palepu, 1999. "Stock Performance and Intermediation Changes Surrounding Sustained Increases in Disclosure," Contemporary Accounting Research, John Wiley & Sons, vol. 16(3), pages 485-520, September.
    4. El Ghoul, Sadok & Guedhami, Omrane & Kwok, Chuck C.Y. & Mishra, Dev R., 2011. "Does corporate social responsibility affect the cost of capital?," Journal of Banking & Finance, Elsevier, vol. 35(9), pages 2388-2406, September.
    5. Inder K. Khurana & K. K. Raman, 2003. "Are Fundamentals Priced in the Bond Market?," Contemporary Accounting Research, John Wiley & Sons, vol. 20(3), pages 465-494, September.
    6. Barber, Brad M & Lyon, John D, 1997. "Firm Size, Book-to-Market Ratio, and Security Returns: A Holdout Sample of Financial Firms," Journal of Finance, American Finance Association, vol. 52(2), pages 875-883, June.
    7. Gopal V. Krishnan & James A. Largay III, 2000. "The Predictive Ability of Direct Method Cash Flow Information," Journal of Business Finance & Accounting, Wiley Blackwell, vol. 27(1‐2), pages 215-245, January.
    8. Steven Glazerman & Dan M. Levy & David Myers, 2003. "Nonexperimental Versus Experimental Estimates of Earnings Impacts," The ANNALS of the American Academy of Political and Social Science, , vol. 589(1), pages 63-93, September.
    9. Tom Smith & Kathleen Walsh, 2013. "Why the CAPM is Half-Right and Everything Else is Wrong," Abacus, Accounting Foundation, University of Sydney, vol. 49, pages 73-78, January.
    10. Pamela Kent & James Routledge & Jenny Stewart, 2010. "Innate and discretionary accruals quality and corporate governance," Accounting and Finance, Accounting and Finance Association of Australia and New Zealand, vol. 50(1), pages 171-195, March.
    11. Gopal V. Krishnan & James A. Largay III, 2000. "The Predictive Ability of Direct Method Cash Flow Information," Journal of Business Finance & Accounting, Wiley Blackwell, vol. 27(1&2), pages 215-245.
    12. Peter M. Clarkson & Colin Ferguson & Jason Hall, 2003. "Auditor conservatism and voluntary disclosure: Evidence from the Year 2000 systems issue," Accounting and Finance, Accounting and Finance Association of Australia and New Zealand, vol. 43(1), pages 21-40, March.
    13. Indra Abeysekera, 2012. "Role of remuneration committee in narrative human capital disclosure," Accounting and Finance, Accounting and Finance Association of Australia and New Zealand, vol. 52, pages 1-23, October.
    14. Philip Gray & Ping‐Sheng Koh & Yen H Tong, 2009. "Accruals Quality, Information Risk and Cost of Capital: Evidence from Australia," Journal of Business Finance & Accounting, Wiley Blackwell, vol. 36(1‐2), pages 51-72, January.
    15. Barth, ME & Clinch, G, 1998. "Revalued financial, tangible, and intangible assets: Associations with share prices and non-market-based value estimates," Journal of Accounting Research, Wiley Blackwell, vol. 36, pages 199-233.
    16. repec:mpr:mprres:3694 is not listed on IDEAS
    17. Klammer, Thomas P. & Reed, Sarah A., 1990. "Operating cash flow formats: Does format influence decisions?," Journal of Accounting and Public Policy, Elsevier, vol. 9(3), pages 217-235.
    18. David A. Ziebart & Sara A. Reiter, 1992. "Bond ratings, bond yields and financial information," Contemporary Accounting Research, John Wiley & Sons, vol. 9(1), pages 252-282, September.
    19. David E. Rapach & Jack K. Strauss & Guofu Zhou, 2010. "Out-of-Sample Equity Premium Prediction: Combination Forecasts and Links to the Real Economy," The Review of Financial Studies, Society for Financial Studies, vol. 23(2), pages 821-862, February.
    20. C. Cheng & Dana Hollie, 2008. "Do core and non-core cash flows from operations persist differentially in predicting future cash flows?," Review of Quantitative Finance and Accounting, Springer, vol. 31(1), pages 29-53, July.
    21. Paul E. Fischer & Robert E. Verrecchia, 1997. "The Effect of Limited Liability on the Market Response to Disclosure," Contemporary Accounting Research, John Wiley & Sons, vol. 14(3), pages 515-541, September.
    22. Husam Aldamen & Keith Duncan, 2013. "Pricing of innate and discretionary accruals in Australian debt," Accounting and Finance, Accounting and Finance Association of Australia and New Zealand, vol. 53(1), pages 31-53, March.
    23. Beaver, Wh, 1968. "Information Content Of Annual Earnings Announcements," Journal of Accounting Research, Wiley Blackwell, vol. 6, pages 67-92.
    24. C.S. Agnes Cheng & Simon S.M. Yang, 2003. "The Incremental Information Content of Earnings and Cash Flows from Operations Affected by Their Extremity," Journal of Business Finance & Accounting, Wiley Blackwell, vol. 30(1-2), pages 73-116.
    25. Raghavan (Raj) J. Iyengar & H. James Williams & Ernest M. Zampelli, 2005. "Sensitivity of executive pay to accounting performance measures in all‐equity firms," Accounting and Finance, Accounting and Finance Association of Australia and New Zealand, vol. 45(4), pages 577-595, December.
    26. Philip Brown & Wendy Beekes & Peter Verhoeven, 2011. "Corporate governance, accounting and finance: A review," Accounting and Finance, Accounting and Finance Association of Australia and New Zealand, vol. 51(1), pages 96-172, March.
    27. Theodore J. Mock & Sunita S. Rao & Rajendra P. Srivastava, 2013. "The Development of Worldwide Sustainability Reporting Assurance," Australian Accounting Review, CPA Australia, vol. 23(4), pages 280-294, December.
    28. Fama, Eugene F & French, Kenneth R, 1996. "Multifactor Explanations of Asset Pricing Anomalies," Journal of Finance, American Finance Association, vol. 51(1), pages 55-84, March.
    29. Gavin Cassar & Scott Holmes, 2003. "Capital structure and financing of SMEs: Australian evidence," Accounting and Finance, Accounting and Finance Association of Australia and New Zealand, vol. 43(2), pages 123-147.
    30. Yi Meng Chen & Robyn Moroney & Keith Houghton, 2005. "Audit committee composition and the use of an industry specialist audit firm," Accounting and Finance, Accounting and Finance Association of Australia and New Zealand, vol. 45(2), pages 217-239, July.
    31. Robin Greenwood & Samuel G. Hanson, 2013. "Issuer Quality and Corporate Bond Returns," The Review of Financial Studies, Society for Financial Studies, vol. 26(6), pages 1483-1525.
    32. Fama, Eugene F. & French, Kenneth R., 1993. "Common risk factors in the returns on stocks and bonds," Journal of Financial Economics, Elsevier, vol. 33(1), pages 3-56, February.
    33. Jacqueline Christensen & Pamela Kent & James Routledge & Jenny Stewart & Gary Monroe, 2015. "Do corporate governance recommendations improve the performance and accountability of small listed companies?," Accounting and Finance, Accounting and Finance Association of Australia and New Zealand, vol. 55(1), pages 133-164, March.
    34. C. Elizabeth Plummer & Senyo Y. Tse, 1999. "The Effect of Limited Liability on the Informativeness of Earnings: Evidence from the Stock and Bond Markets," Contemporary Accounting Research, John Wiley & Sons, vol. 16(3), pages 541-574, September.
    35. Philip Gray & Ping-Sheng Koh & Yen H Tong, 2009. "Accruals Quality, Information Risk and Cost of Capital: Evidence from Australia," Journal of Business Finance & Accounting, Wiley Blackwell, vol. 36(1-2), pages 51-72.
    36. William F. Sharpe, 1964. "Capital Asset Prices: A Theory Of Market Equilibrium Under Conditions Of Risk," Journal of Finance, American Finance Association, vol. 19(3), pages 425-442, September.
    37. Ball, R & Brown, P, 1968. "Empirical Evaluation Of Accounting Income Numbers," Journal of Accounting Research, Wiley Blackwell, vol. 6(2), pages 159-178.
    38. Kamran Ahmed & Darren Henry, 2012. "Accounting conservatism and voluntary corporate governance mechanisms by Australian firms," Accounting and Finance, Accounting and Finance Association of Australia and New Zealand, vol. 52(3), pages 631-662, September.
    39. Dichev, Ilia D. & Graham, John R. & Harvey, Campbell R. & Rajgopal, Shiva, 2013. "Earnings quality: Evidence from the field," Journal of Accounting and Economics, Elsevier, vol. 56(2), pages 1-33.
    40. Diamond, Douglas W & Verrecchia, Robert E, 1991. "Disclosure, Liquidity, and the Cost of Capital," Journal of Finance, American Finance Association, vol. 46(4), pages 1325-1359, September.
    41. Richard Lambert & Christian Leuz & Robert E. Verrecchia, 2007. "Accounting Information, Disclosure, and the Cost of Capital," Journal of Accounting Research, Wiley Blackwell, vol. 45(2), pages 385-420, May.
    42. Shi, Charles, 2003. "On the trade-off between the future benefits and riskiness of R&D: a bondholders' perspective," Journal of Accounting and Economics, Elsevier, vol. 35(2), pages 227-254, June.
    43. Iain Clacher & Alan Duboisée Ricquebourg & Allan Hodgson, 2013. "The Value Relevance of Direct Cash Flows under International Financial Reporting Standards," Abacus, Accounting Foundation, University of Sydney, vol. 49(3), pages 367-395, September.
    44. Pamela Kent & Jenny Stewart, 2008. "Corporate governance and disclosures on the transition to International Financial Reporting Standards," Accounting and Finance, Accounting and Finance Association of Australia and New Zealand, vol. 48(4), pages 649-671, December.
    45. William R. Gebhardt & Charles M. C. Lee & Bhaskaran Swaminathan, 2001. "Toward an Implied Cost of Capital," Journal of Accounting Research, Wiley Blackwell, vol. 39(1), pages 135-176, June.
    46. Wael Mostafa & Rob Dixon, 2013. "The impact of earnings extremity on information content of cash flow," Review of Accounting and Finance, Emerald Group Publishing Limited, vol. 12(1), pages 81-104, February.
    47. Healy, Paul M. & Palepu, Krishna G., 2001. "Information asymmetry, corporate disclosure, and the capital markets: A review of the empirical disclosure literature," Journal of Accounting and Economics, Elsevier, vol. 31(1-3), pages 405-440, September.
    48. Neil Fargher & Alicia Jiang & Yangxin Yu & Gary Monroe, 2014. "How do auditors perceive CEO's risk-taking incentives?," Accounting and Finance, Accounting and Finance Association of Australia and New Zealand, vol. 54(4), pages 1157-1181, December.
    49. Ping‐Sheng Koh & Stacie Kelley Laplante & Yen H. Tong, 2007. "Accountability and value enhancement roles of corporate governance," Accounting and Finance, Accounting and Finance Association of Australia and New Zealand, vol. 47(2), pages 305-333, June.
    50. Sascha O. Becker & Andrea Ichino, 2002. "Estimation of average treatment effects based on propensity scores," Stata Journal, StataCorp LP, vol. 2(4), pages 358-377, November.
    51. James Lau & Philip Sinnadurai & Sue Wright, 2009. "Corporate governance and chief executive officer dismissal following poor performance: Australian evidence," Accounting and Finance, Accounting and Finance Association of Australia and New Zealand, vol. 49(1), pages 161-182, March.
    52. Peter Baxter & Julie Cotter, 2009. "Audit committees and earnings quality," Accounting and Finance, Accounting and Finance Association of Australia and New Zealand, vol. 49(2), pages 267-290, June.
    53. Yuhong Xu, 2014. "Robust valuation and risk measurement under model uncertainty," Papers 1407.8024, arXiv.org.
    54. Shadi Farshadfar & Reza Monem, 2013. "The usefulness of operating cash flow and accrual components in improving the predictive ability of earnings: a re-examination and extension," Accounting and Finance, Accounting and Finance Association of Australia and New Zealand, vol. 53(4), pages 1061-1082, December.
    55. Nelson, Karen K. & Barth, Mary E. & Cram, Donald, 2001. "Accruals and the Prediction of Future Cash Flows," Research Papers 1594r, Stanford University, Graduate School of Business.
    56. Divesh Sharma & Errol Iselin, 2003. "The decision usefulness of reported cash flow and accrual information in a behavioural field experiment," Accounting and Business Research, Taylor & Francis Journals, vol. 33(2), pages 123-135.
    57. Paul Glasserman & Xingbo Xu, 2014. "Robust risk measurement and model risk," Quantitative Finance, Taylor & Francis Journals, vol. 14(1), pages 29-58, January.
    58. Jenny Goodwin‐Stewart & Pamela Kent, 2006. "Relation between external audit fees, audit committee characteristics and internal audit," Accounting and Finance, Accounting and Finance Association of Australia and New Zealand, vol. 46(3), pages 387-404, September.
    59. Ryan Davidson & Jenny Goodwin‐Stewart & Pamela Kent, 2005. "Internal governance structures and earnings management," Accounting and Finance, Accounting and Finance Association of Australia and New Zealand, vol. 45(2), pages 241-267, July.
    60. Christine Contessotto & Robyn Moroney & Gary Monroe, 2014. "The association between audit committee effectiveness and audit risk," Accounting and Finance, Accounting and Finance Association of Australia and New Zealand, vol. 54(2), pages 393-418, June.
    61. Simin, Timothy, 2008. "The Poor Predictive Performance of Asset Pricing Models," Journal of Financial and Quantitative Analysis, Cambridge University Press, vol. 43(2), pages 355-380, June.
    Full references (including those not matched with items on IDEAS)

    Citations

    Citations are extracted by the CitEc Project, subscribe to its RSS feed for this item.
    as


    Cited by:

    1. Li Cui & Pamela Kent & Sujin Kim & Shan Li, 2021. "Accounting conservatism and firm performance during the COVID‐19 pandemic," Accounting and Finance, Accounting and Finance Association of Australia and New Zealand, vol. 61(4), pages 5543-5579, December.
    2. Hu, Jun & Long, Wenbin & Dai, Ming & (Troy) Yao, Daifei, 2022. "Does international experience of managers bring financing benefits? Evidence from the cost of equity capital," Journal of Contemporary Accounting and Economics, Elsevier, vol. 18(1).
    3. Amitav Saha & Sudipta Bose, 2021. "Do IFRS disclosure requirements reduce the cost of capital? Evidence from Australia," Accounting and Finance, Accounting and Finance Association of Australia and New Zealand, vol. 61(3), pages 4669-4701, September.
    4. Pamela Kent & Richard Kent & Robyn McCormack & Julie‐Anne Tarr, 2023. "Disclosure of liquidity and cash flow statements by Australian superannuation funds before Covid‐19," Accounting and Finance, Accounting and Finance Association of Australia and New Zealand, vol. 63(2), pages 2653-2675, June.
    5. Ahmed Saleh & Ahmed Aboud & Yasser Eliwa, 2023. "IFRS 8 and the cost of capital in Europe," International Journal of Finance & Economics, John Wiley & Sons, Ltd., vol. 28(3), pages 3198-3231, July.
    6. Mai, Nhat Chi, 2020. "Related Party Transactions, State Ownership, the Cost of Corporate Debt, and Corporate Tax Avoidance: Evidence from Vietnam," OSF Preprints y5qj3, Center for Open Science.

    Most related items

    These are the items that most often cite the same works as this one and are cited by the same works as this one.
    1. Richard Kent & Jacqueline Birt, 2021. "IAS 7 and value relevance: the direct method versus the indirect method," Review of Accounting Studies, Springer, vol. 26(4), pages 1532-1586, December.
    2. David Hay & Jenny Stewart & Nives Botica Redmayne, 2017. "The Role of Auditing in Corporate Governance in Australia and New Zealand: A Research Synthesis," Australian Accounting Review, CPA Australia, vol. 27(4), pages 457-479, December.
    3. Wijayana, Singgih & Gray, Sidney J., 2018. "Capital market consequences of cultural influences on earnings: The case of cross-listed firms in the U.S. stock market," International Review of Financial Analysis, Elsevier, vol. 57(C), pages 134-147.
    4. Schreder, Max, 2018. "Idiosyncratic information and the cost of equity capital: A meta-analytic review of the literature," Journal of Accounting Literature, Elsevier, vol. 41(C), pages 142-172.
    5. Max Schreder & Pawel Bilinski, 2022. "Information Quality and the Expected Rate of Return: A Structural Equation Modelling Approach," Asia-Pacific Financial Markets, Springer;Japanese Association of Financial Economics and Engineering, vol. 29(2), pages 139-170, June.
    6. Pope, Peter F., 2010. "Bridging the gap between accounting and finance," The British Accounting Review, Elsevier, vol. 42(2), pages 88-102.
    7. Dhaliwal, Dan & Judd, J. Scott & Serfling, Matthew & Shaikh, Sarah, 2016. "Customer concentration risk and the cost of equity capital," Journal of Accounting and Economics, Elsevier, vol. 61(1), pages 23-48.
    8. Terry Shevlin, 2013. "Some personal observations on the debate on the link between financial reporting quality and the cost of equity capital," Australian Journal of Management, Australian School of Business, vol. 38(3), pages 447-473, December.
    9. Mouselli, Sulaiman & Jaafar, Aziz & Hussainey, Khaled, 2012. "Accruals quality vis-à-vis disclosure quality: Substitutes or complements?," The British Accounting Review, Elsevier, vol. 44(1), pages 36-46.
    10. David DeBoskey & Peter Gillett, 2013. "The impact of multi-dimensional corporate transparency on us firms’ credit ratings and cost of capital," Review of Quantitative Finance and Accounting, Springer, vol. 40(1), pages 101-134, January.
    11. Barth, Mary E. & Konchitchki, Yaniv & Landsman, Wayne R., 2013. "Cost of capital and earnings transparency," Journal of Accounting and Economics, Elsevier, vol. 55(2), pages 206-224.
    12. Jennifer Francis & Dhananjay Nanda & Per Olsson, 2008. "Voluntary Disclosure, Earnings Quality, and Cost of Capital," Journal of Accounting Research, Wiley Blackwell, vol. 46(1), pages 53-99, March.
    13. Roychowdhury, Sugata & Shroff, Nemit & Verdi, Rodrigo S., 2019. "The effects of financial reporting and disclosure on corporate investment: A review," Journal of Accounting and Economics, Elsevier, vol. 68(2).
    14. Martina K. Linnenluecke & Jacqueline Birt & Xiaoyan Chen & Xin Ling & Tom Smith, 2017. "Accounting Research in Abacus, A&F, AAR, and AJM from 2008–2015: A Review and Research Agenda," Abacus, Accounting Foundation, University of Sydney, vol. 53(2), pages 159-179, June.
    15. Filippo Vitolla & Antonio Salvi & Nicola Raimo & Felice Petruzzella & Michele Rubino, 2020. "The impact on the cost of equity capital in the effects of integrated reporting quality," Business Strategy and the Environment, Wiley Blackwell, vol. 29(2), pages 519-529, February.
    16. Jacqueline Christensen & Pamela Kent & James Routledge & Jenny Stewart & Gary Monroe, 2015. "Do corporate governance recommendations improve the performance and accountability of small listed companies?," Accounting and Finance, Accounting and Finance Association of Australia and New Zealand, vol. 55(1), pages 133-164, March.
    17. Stephen Dempsey & David Harrison & Kimberly Luchtenberg & Michael Seiler, 2012. "Financial Opacity and Firm Performance: The Readability of REIT Annual Reports," The Journal of Real Estate Finance and Economics, Springer, vol. 45(2), pages 450-470, August.
    18. Brushwood, James & Dhaliwal, Dan & Fairhurst, Douglas & Serfling, Matthew, 2016. "Property crime, earnings variability, and the cost of capital," Journal of Corporate Finance, Elsevier, vol. 40(C), pages 142-173.
    19. Misund, Bård, 2015. "Vertical Integration and Value Relevance: Empirical Evidence from Oil and Gas Producers," UiS Working Papers in Economics and Finance 2015/14, University of Stavanger.
    20. Eliwa, Yasser & Haslam, Jim & Abraham, Santhosh, 2021. "Earnings quality and analysts’ information environment: Evidence from the EU market," Journal of International Accounting, Auditing and Taxation, Elsevier, vol. 42(C).

    More about this item

    Statistics

    Access and download statistics

    Corrections

    All material on this site has been provided by the respective publishers and authors. You can help correct errors and omissions. When requesting a correction, please mention this item's handle: RePEc:bla:acctfi:v:60:y:2020:i:s1:p:877-908. See general information about how to correct material in RePEc.

    If you have authored this item and are not yet registered with RePEc, we encourage you to do it here. This allows to link your profile to this item. It also allows you to accept potential citations to this item that we are uncertain about.

    If CitEc recognized a bibliographic reference but did not link an item in RePEc to it, you can help with this form .

    If you know of missing items citing this one, you can help us creating those links by adding the relevant references in the same way as above, for each refering item. If you are a registered author of this item, you may also want to check the "citations" tab in your RePEc Author Service profile, as there may be some citations waiting for confirmation.

    For technical questions regarding this item, or to correct its authors, title, abstract, bibliographic or download information, contact: Wiley Content Delivery (email available below). General contact details of provider: https://edirc.repec.org/data/aaanzea.html .

    Please note that corrections may take a couple of weeks to filter through the various RePEc services.

    IDEAS is a RePEc service. RePEc uses bibliographic data supplied by the respective publishers.