Which Free Cash Flow Is Value Relevant? The Case of the Healthcare Industry

• In Event: Financial Accounting and Reporting 11

Abstract

The objective of this study is to empirically identify which accounting definition of free cash flow (FCF) is the most value relevant for the healthcare industry. The study aims to provide two contributions to the literature: First, the results would help investors make better decisions, and second, the results may encourage the Financial Accounting Standards Board (FASB) to require healthcare companies to use a specific definition of FCF. Using correlations and multiple regression analysis on a sample of 14,866 observations covering the 23-year period from 1988 to 2010, the author empirically shows that the FCF that has the most significant association with stock price changes, after controlling for many factors that may affect stock prices, is the one defined as cash flow from operations less capital expenditures. The author recommends that the FASB require healthcare companies to disclose that FCF in the body of the Statement of Cash Flows or at its bottom together with the cash outflow for income taxes and interest expense. Short of that, the FASB should at least require healthcare companies that voluntarily disclose FCF to use only the FCF definition identified by this study.

Author

• Mostafa M Maksy, Kutztown University of Pennsylvania