INFORMATION CONTENT OF CASH FLOW FROM OPERATIONS IN THE PREDICTION OF FUTURE EARNINGS : THE CASE OF SINGAPORE

Abstract

Previous studies (Myers and Majluf [1984] and others) indicate that exterr.al funds cannot be a perfect substitute for internal funds because there exists a cost difference between internal funds and external funds. Internally generated funds are usually cheaper than funds raised externally. Finns thus have to face financing constraints due to their limited ability of obtaining internal funds. The tightness of financing constraint and the cost differential of internal financing and external financing can impact on the amount of information content of cash flow from operations (CFO) beyond accounting earnings (see Johnson and Lee [1994] ). The objective of this thesis is to assess the generality of Johnson and Lee's finding about the incremental information content of CFO, and to examine other factors which could have an impact on investment expenditures of firms. We first conduct a similar test as Johnson and Lee's for Singapore firms. Our results support their findings. CFO carries more incremental information beyond accounting earnings when a firm faces tight financial constraint and great cost differential between internal funds and external funds. We then extend the test to examine the impact of free cash flow on CFO's informativeness. We find that the incremental information content of CFO increases as the level of free cash flow of the firm declines.