using operating cash flow data to predict financial distress some extensions.pdf

using operating cash flow data to predict financial distress some extensions.pdf

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WileyandAccountingResearchCenter,BoothSchoolofBusiness,UniversityofChicagoarecollaboratingwithJSTORtodigitize,preserveandextendaccesstoJournalofAccountingResearch.http:

/www.jstor.orgAccountingResearchCenter,BoothSchoolofBusiness,UniversityofChicagoAccountingResearchCenter,BoothSchoolofBusiness,UniversityofChicagoUsingOperatingCashFlowDatatoPredictFinancialDistress:

SomeExtensionsAuthor（s）:

CorneliusCaseyandNormanBartczakSource:

JournalofAccountingResearch,Vol.23,No.1（Spring,1985）,pp.384-401Publishedby:

onbehalfofWileyAccountingResearchCenter,BoothSchoolofBusiness,UniversityofChicagoStableURL:

http:

/www.jstor.org/stable/2490926Accessed:

12-04-201522:

28UTCYouruseoftheJSTORarchiveindicatesyouracceptanceoftheTerms&ConditionsofUse,availableathttp:

/www.jstor.org/page/info/about/policies/terms.jspJSTORisanot-for-profitservicethathelpsscholars,researchers,andstudentsdiscover,use,andbuilduponawiderangeofcontentinatrusteddigitalarchive.Weuseinformationtechnologyandtoolstoincreaseproductivityandfacilitatenewformsofscholarship.FormoreinformationaboutJSTOR,pleasecontactsupportjstor.org.Thiscontentdownloadedfrom130.194.20.173onSun,12Apr201522:

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43UTCAllusesubjecttoJSTORTermsandConditionsJournalofAccountingResearchVol.23No.1Spring1985PrintedinU.S.A.UsingOperatingCashFlowDatatoPredictFinancialDistress:

SomeExtensionsCORNELIUSCASEY*ANDNORMANBARTCZAKt1.IntroductionRecently,financialstatementusersandregulatorsofpubliclyreportedfinancialaccountingdatahavearguedinfavorofthedisclosureofdetailedinformationonfirmscurrentoperatingcashflows（Harrisetal.1980,FASB1981,Smith1982,andThomas1982）.TheFASBsuggeststhatsuchdisclosureswillallowuserstoassessbettertheamount,timing,anduncertaintyoffuturecashflows.Itstatesthatthegreatertheamountoffuturenetcashinflowsfromoperations,thegreatertheabilityoftheenterprisetowithstandadversechangesinoperatingconditions1981,p.11.Thepresumptionthathistoricaloperatingcashflowsenablebetterassessmentsoffuturecashflows,however,isbasedonintuitionratherthanonempiricalevidence（Griffin1982）.Ourstudywasconductedtoassesswhetheroperatingcashflowdataandrelatedmeasuresleadtomoreaccuratepredictionsofbankruptand*AssociateProfessor,DartmouthCollege-theEditorsoftheJournalofAccountingResearchweresaddenedtolearnofthedeathofProfessorCaseyinOctober1984;tLecturer,HarvardUniversity.Theauthorsgratefullyacknowledgethehelpfulcommentsofpartici-pantsinaccountingworkshopsatseveraluniversities.SuggestionsmadebyE.Altman,P.Griffin,J.Horrigan,W.Mikkelson,T.Selling,J.Shank,C.Stickney,andP.Williamsonareappreciated,asisthecomputingassistancerenderedbyD.Bower,S.Hare,D.Roberts,andG.Peterson.J.Ohlsonkindlyprovidedmanyofthefinancialstatementsforthebankruptfirms.FundingforthisprojectwasprovidedbytheTuckAssociates,DartmouthCollege,andtheDivisionofResearch,HarvardBusinessSchool.AcceptedforpublicationSeptember1984.384CopyrightC）,InstituteofProfessionalAccounting1985Thiscontentdownloadedfrom130.194.20.173onSun,12Apr201522:

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43UTCAllusesubjecttoJSTORTermsandConditionsUSINGOPERATINGCASHFLOWDATA385nonbankruptfirms.Recentstudies（GombolaandKetz1983andGombolaetal.1983）foundthatratiosbasedonoperatingcashflowloadonaseparatestatisticalfactor,suggestingthatoperatingcashflowvariablesmaybeusefulindescriptiveandpredictivestudiesinvolvingfinancialratios.Ourresultssuggestotherwise,atleastwithrespecttobankruptcyprediction.Inanotherstudy（CaseyandBartczak1984）wereportedthataccrual-basedmultivariatediscriminantmodelsforecastedcorporatebankruptcymoreaccuratelythananysingleoperatingcashflowratio.Thefocusofthepresentstudyisonthemarginalpredictivecontentoftheoperatingcashflowratios,incontrasttoourpreviousstudywhichexaminedtheirunivariatepredictivevalue.Thepoorperformanceoftheoperatingcashflowratiosinthepreviousstudydoesnotprecludetheirabilitytoenhancepredictivepowerwhenusedincombinationwithaccrual-basedratios.Previousaccountingstudieshavebeenunabletodocumenttheexistenceofincrementalinformationcontentinoperatingcashflowdata（Bowen,Burgstahler,andDaley1984）.Unlikethepresentstudy,thesestudieshaveusedrestrictivesurrogatesformeasuringcashflowfromoperations,andthustheissueofwhetheroperatingcashflowdatahaveincrementalinformationvalueisunresolved.Insection2wereviewpriorbankruptcystudiesthathaveexaminedthepotentialusefulnessofoperatingcashflowdata.Section3describesthemethodologyemployedinthepresentstudy,includingselectionofsamplefirmsandanalysesappliedtothefirmsaccountingdata.Resultsarepresentedinsection4,followedbysomelimitationsofthestudyandpossibledirectionsforfuturerelatedresearchinsection5.2.PreviousResearchMostaccountingandfinancestudiesofcorporatefinancialdistressdefinecashflowasnetincomeplusnonworkingcapitalexpenses,sotheyomititemssuchaschangesincurrentassetsandcurrentliabilitieswhichmayhaveasignificantimpactonacompanysactualcashflowfromoperations.Thishasledtosuggestionsforbroadermeasuresofcashflows（e.g.,LargayandStickney1980andGombolaandKetz1983）.Ourdefinitionofcashflowfromoperations（CFO）isessentiallythesameBankruptcywasselectedasthespecificformoffinancialdistressandasthecriterioneventforthreeprimaryreasons:

（1）thedirectandindirectcostsofbankruptcyaresignificantinrelationtothevalueofthefirm（Altman1983a）:

（2）resultsfromthisstudycanbecomparedwithpreviousstudiesofbankruptcyprediction;（3）thecostsofdatagatheringandtheproblemofinterpretingtheeconomicsignificanceofotherevents（e.g.,loandefault）wereviewedasgreaterthanthebenefitsofusingeventswhoseoccurrencesarearguablylesssubjecttononeconomicfactorsthanisbankruptcy.Thus,whilebankruptcypredictionperseisnotthemainfocusofthisstudy,bankruptcyisnonethelessaconvenienteventforassessingoneaspectoftheinformationvalueofoperatingcashflowdata.Thiscontentdownloadedfrom130.194.20.173onSun,12Apr201522:

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43UTCAllusesubjecttoJSTORTermsandConditions386JOURNALOFACCOUNTINGRESEARCH,SPRING1985astheirs:

workingcapitalprovidedbyoperations,plusorminuschangesinthenoncashworkingcapitalaccountsexceptforshort-termindebt-edness（seasonalbankloans,nontradenotespayable,andthecurrentportionoflong-termdebt）.ThisconceptofoperatingcashflowisalsoconsistentwiththerecentFASBExposureDraft1981.EmpiricalresearchontherelationshipbetweenCFOandfinancialdistresshasprovidedonlylimitedevidencethatsuchdataareusefulindiscriminatingbetweentroubledandhealthyfirms（table1）.Noneofthestudieslistedtherewasvalidatedusingseparateholdoutsamplesofbankruptcompanies.Moreover,theproportionoffailedfirmsinallofthestudiesexceptthatofLargayandStickney19801,whichinvolvedonlyonecompany,wasclosetoorequalto50%.Thisislikelytoleadtoartificiallylowoverallerrorrates（Deakin1977）.2Somebasicdifferencesbetweenourstudyandthoseofpreviousstudiesare:

（1）afocusonthepotentialmarginalimprovementinclassificationaccuracyusingCFO;

（2）alargernumberofsamplefirmsandasmallerproportionoffailedfirms;（3）avalidationoftheresultsbasedonaholdoutsample;（4）apreliminarycanonicalcorrelationanalysisoftheamountofvarianceintheoperatingcashflowratiosalreadyaccountedforbyaccrual-basedratios;and（5）theinclusionoffirst-orderinterac-tionsbetweentheoperatingcashflowandaccrual-basedratios.TheexpectationoftheFASB（andothers）thatthelevelofoperatingcashflowwillserveasausefulindicatorofthelikelihoodoffinancialdistressdoesnotderivefromanyformaltheory.Itismerelyconsistentwithanapparentshiftinpreferencebymanyanalyststousecashflowdataforassessingafirmsfinancialperformance（Hawkins1977）.Thepresentstudyneitherproposesnortestsanytheoryoftheprobabilityoffinancialdistress.Whilesuchtheoriesdoexist（seeScott1981forasurvey;alsoEmeryandCogger1982）,noonetheoryisgenerallyaccepted（BallandFoster1982）andnonegivesspecificattentiontoourmeasureofoperatingcashflow.3.Method3.1SAMPLEFIRMSThesamplefirmsarethesamecompaniesusedinourpreviousstudyonoperatingcashflows（CaseyandBartczak1984）.Sixtyfirmswereselectedthathadpetitionedforbankruptcyduringtheperiod1971-82.Thebankruptfirmswereasubsetofthe105failedfirmsusedinapreviousstudy（Ohlson1980）andincludedfirmslistedbyDunandBradstreetandtheWallStreetJournalIndex.Criteriaforinclusionin2TypeIIerroristheclassificationofanonfailedfirmasfailed;TypeIerroristheclassificationofafailedfirmasnonfailed;overallerrorrateisaweightedcombinationofTypeIandTypeIIerrorrates.Thiscontentdownloadedfrom130.194.20.173onSun,12Apr201522:

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43UTCAllusesubjecttoJSTORTermsandConditionsUSINGOPERATINGCASHFLOWDATA387thepresentstudywere:

（1）thestockofthecompanywaspubliclytraded,and

（2）atleastfive,andinsomecasessix,yearsofpublishedfinancialstatementswereavailablepriortothefailuredate.Thefirstcriterionwasimposedinordertoundertakearelatedstudyinvolvingmarketvaluedata.Thesecondallowedfortheinclusionofatrendvariableintheanalyses.Wealsomadesurethatthedataforthefirstyearpriortofailurewereactuallypubliclyavailablepriortothebankruptcypetitiondate（Ohlson1980）byrequiringall