Accruals, Cash Flows and the Post-Earnings-Announcement Drift


  • Lakshmanan Shivakumar

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      The author is from the London Business School. He has benefited from the comments of Tarun Chordia and an anonymous referee. Financial support from the Deans’ Research Fund at London Business School is gratefully acknowledged. (Paper received March 2002, revised version accepted December 2004)

†Lakshmanan Shivakumar, London Business School, Regent's Park, London NW1 4SA, UK.


Abstract:  Several prior studies have shown that cash flows have significantly greater impact on stock prices than accruals. We examine the implications of these findings for the post-earnings-announcement-drift anomaly. We argue that, if investors under-react to earnings news, then the larger price impact of cash flows causes the cash flow component of earnings news to predict future returns better than the accruals component. Consistent with this argument, we show that unexpected cash flows are more positively related to future returns, than are unexpected accruals. Also, unexpected cash flows are found to predict future returns above and beyond that predicted by earnings surprises. Finally, we show that a strategy that decomposes earnings news into its components significantly outperforms strategies based on earnings news alone. The results support under-reaction explanations for the drift.