ACCOUNTING EARNINGS AND CASH FLOWS AS MEASURES OF FIRM PERFORMANCE - THE ROLE OF ACCOUNTING ACCRUALS

This paper investigates circumstances under which accruals are predicted to improve earnings' ability to measure firm performance, as reflected in stock returns. The importance of accruals is hypothesized to increase (i) the shorter the performance measurement interval, (ii) the greater the volatility of the firm's working capital requirements and investment and financing activities, and (iii) the longer the firm's operating cycle. Under each of these circumstances, cash flows are predicted to suffer more severely from timing and matching problems that reduce their ability to reflect firm performance. The results of empirical tests are consistent with these predictions.