The Effect of Contextual Factors on the Information Content of Cash Flows in Explaining Stock Prices - the Case of Amman Stock Exchange

This article aims to determine which is better earnings or cash flows as a performance measure. We follow the more direct approach used in several recent US studies, in which earnings and cash flows are considered as competing variables. Specifically, our methodology is a development of the study of Dechow (1994). We provide a replication of her main analysis, and then extend this to deal with the effect of earnings permanence, earnings growth and firm size on the value relevance of cash flow and earnings. Our study provides an evidence on the relevance of cash flow figures for investors in their investment decision in an emerging stock market. The study covers the case of Amman Stock Exchange (ASE) and employs data on a sample of industrial firms. The time horizon of this study includes the period of 1993-2001. The results of the current study indicate that earnings and cash flows have information content regarding the prediction of future cash flows. Cash flows and earnings separately have a significant association with stock return. The results show that there is no significant difference between the ability of earnings and cash flows in explaining the variation in stock return. Furthermore, as the earnings growth is low and the firm’s size is small, the operating cash flow is considered better than earnings as a performance measure.