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Auditor quality effects on the relationship between accruals, cash flows and equity returns: a variance decomposition analysis

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  • Mark A. Clatworthy
  • Christopher K.M. Pong
  • Woon K. Wong

Abstract

In this paper, we examine the relative importance of the cash flow and accruals components of earnings in explaining the variation in UK company equity returns, together with the extent to which these relationships vary by auditor quality. We use a multivariate time-series approach that can be reconciled to a log-linear theoretical valuation model and, unlike the standard linear regression of returns on earnings components, accommodates time-varying discount rates. Based on a decomposition of the variance of equity returns, cash flows and accruals, our results indicate that both cash flow news and accruals news are important drivers of UK equity returns, although cash flows are more influential than accruals. We also find that variation in both earnings components has a more significant effect on returns for clients of large auditors. Finally, our results provide mixed evidence on the question of whether the impact of auditor quality is highest for the accruals component of earnings.

Suggested Citation

  • Mark A. Clatworthy & Christopher K.M. Pong & Woon K. Wong, 2012. "Auditor quality effects on the relationship between accruals, cash flows and equity returns: a variance decomposition analysis," Accounting and Business Research, Taylor & Francis Journals, vol. 42(4), pages 419-439, September.
    • Handle: RePEc:taf:acctbr:v:42:y:2012:i:4:p:419-439
    DOI: 10.1080/00014788.2012.662791
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    Cited by:

    1. Ahmed Hassanein & Alaa Zalata & Khaled Hussainey, 2019. "Do forward-looking narratives affect investors’ valuation of UK FTSE all-shares firms?," Review of Quantitative Finance and Accounting, Springer, vol. 52(2), pages 493-519, February.
    2. Dimos Andronoudis & Diogenis Baboukardos & Fanis Tsoligkas, 2024. "How the information content of integrated reporting flows into the stock market," International Journal of Finance & Economics, John Wiley & Sons, Ltd., vol. 29(1), pages 1057-1078, January.
    3. Dimos Andronoudis & Diogenis Baboukardos & Fanis Tsoligkas, 2024. "How the information content of integrated reporting flows into the stock market," Post-Print hal-04389552, HAL.

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