Separating Information about Cash Flows from Information about Risk in Losses

• In Event: Accounting Information and the Cost of Capital

Abstract

This paper investigates whether accounting losses provide distinct and offsetting information about future cash flows and about risk to investors. I predict and find that losses contain value-decreasing information about future cash flows and value-increasing information about risk; these two types of information have offsetting effects on stock returns, resulting in a muted return-earnings relation of losses. Further tests show that the extent to which losses convey the two types of information is related to persistence of losses, financial constraints, and liquidity of operating assets. These results suggest that losses contain significant value-relevant information despite their weak overall association with stock returns.

Author

• Bin Li, The University of Texas at Dallas