Joint Meeting of the Mid-Atlantic and Northeast Regions

Earnings versus Cash Flows in Equity Valuation: Evidence from the COVID-19 Crisis

• In Event: Firm Valuation

Abstract

This study investigates the role of earnings and cash flows in equity valuation under severe uncertainty about firm fundamentals. Using the COVID-19 pandemic as an exogenous shock that exacerbates fundamental uncertainty, we find that while earnings dominate cash flows in explaining the cross-section of stock returns during the pre-pandemic period, cash flows outperform earnings during the pandemic period. We also find that the decrease in the value relevance of earnings is attributable to the decline in the valuation weight on the accruals component of earnings. Further analyses reveal that the dominance of cash flows over earnings is less pronounced for operating earnings than for net earnings and that the valuation weight on cash flows increases with the ex-ante exposure to the pandemic shock and the level of financial inflexibility. Our evidence highlights the relative importance of cash flows versus accounting earnings under extreme uncertainty about firms’ prospects.

Authors

• Jeong-Bon Kim, City University of Hong Kong

• Junwoo Kim, Oakland University

• Jay Junghun Lee, University of Massachusetts Boston