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Changes in Cash: Persistence and Pricing Implications

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  • JEFF ZEYUN CHEN
  • PHILIP B. SHANE

Abstract

This paper decomposes the cash component of earnings and analyzes persistence characteristics and pricing implications of various subcomponents, with particular attention to 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.

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  • Jeff Zeyun Chen & Philip B. Shane, 2014. "Changes in Cash: Persistence and Pricing Implications," Journal of Accounting Research, Wiley Blackwell, vol. 52(3), pages 599-634, June.
    • Handle: RePEc:bla:joares:v:52:y:2014:i:3:p:599-634
    DOI: 10.1111/1475-679X.12050
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    2. He, Shuoyuan & Narayanamoorthy, Ganapathi (Gans), 2020. "Earnings acceleration and stock returns," Journal of Accounting and Economics, Elsevier, vol. 69(1).
    3. Cheung, Yan-Leung & Rau, P. Raghavendra & Stouraitis, Aris & Tan, Weiqiang, 2021. "Does the market understand the ex ante risk of expropriation by controlling shareholders?," Journal of Corporate Finance, Elsevier, vol. 68(C).
    4. Greiner, Adam J., 2017. "An examination of real activities management and corporate cash holdings," Advances in accounting, Elsevier, vol. 39(C), pages 79-90.
    5. Artikis, Panagiotis G. & Papanastasopoulos, Georgios A., 2016. "Implications of the cash component of earnings for earnings persistence and stock returns," The British Accounting Review, Elsevier, vol. 48(2), pages 117-133.
    6. Vassilios‐Christos Naoum & Georgios A. Papanastasopoulos, 2021. "The implications of cash flows for future earnings and stock returns within profit and loss firms," International Journal of Finance & Economics, John Wiley & Sons, Ltd., vol. 26(2), pages 2927-2945, April.
    7. Wei Chen & Paul Hribar & Samuel Melessa, 2018. "Incorrect Inferences When Using Residuals as Dependent Variables," Journal of Accounting Research, Wiley Blackwell, vol. 56(3), pages 751-796, June.

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