The Relative and Incremental Information Content of Accounting Earnings Versus the Cash Recovery Rate*
Posted: 15 Sep 2004
Researchers in accounting, economics, and finance are interested in discovering the best measure of economic return. The usefulness of accounting rates of return has been questioned and alternative performance measures are being pursued. One fairly recent measure, the cash recovery rate, is based on continuous time analysis and U-shaped cash flows. We examine the relative and incremental information content of two competing performance measures using Tobin's q and stock returns as benchmarks. The two measures are (1) an accounting rate of return defined as return on assets (ROA), and (2) an estimated internal rate of return (EIRR) derived from the cash recovery rate (CRR). We use both short and long time intervals for our tests. Overall, our results indicate that ROA has no relative or incremental information content whereas EIRR is consistently positively related to both Tobin's q and stock returns over all measurement intervals. These results imply that accounting earnings-based performance measures are less value relevant compared to cash recovery-based measures.
Keywords: Firm performance, accounting rates of return, cash recovery rate, information content
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