On the one hand, less profitable firms could be more likely to make OCF-increasing classification choices, managing OCF upward to compensate for weakness in reported profits. On the other hand, more profitable firms could be likely to make OCF-enhancing classification choices to reflect better cash flow performance consistent with income performance. Therefore we do not predict the sign of the association between profitability and OCF-increasing choices.
S. The presence of an analyst’s cash flow forecast indicates the perceived importance of OCF and the commensurate scrutiny of reported OCF (DeFond and Hung 2003; Call et al. 2009). 2013; Call et al. 2013). The perceived importance of OCF and capital markets incentives imply that firms are more likely to classify interest paid in financing (i.e., make an OCF-enhancing choice) when analysts have issued cash flow forecasts. However, other evidence suggests that analysts’ cash flow forecasts help mitigate earnings management (DeFond and Hung 2003; Wasley and Wu 2006; DeFond and Hung 2007; McInnis and Collins 2011), essentially serving a deterrent role. This possible deterrence suggests that firms are less likely to make an OCF-enhancing classification choice when analysts have issued cash flow forecasts. Therefore we do not predict the sign of an association between analyst following and OCF-increasing classification choices.
We examine three explanatory variables related to the firm’s information environment: (1) availability of analysts’ cash flow forecasts, (2) industry practice, and (3) cross-listing in the U
Our second information-environment variable, industry practice, is relevant to classification choice because firms could be motivated to increase cross-sectional comparability by making classification choices consistent with those of their peer industry group. Footnote 13 For example, when considering the choice of where to report interest paid, a firm could be hurt by classifying interest paid as operating and thus reporting comparatively lower OCF when, for example, the majority of its industry peers classify interest paid as financing. Alternatively, a firm could make a different choice to distinguish itself from its peers and possibly report higher OCF. In this case, OCF-increasing choices would not be expected to be associated with industry practice. Therefore we have no prediction on the sign of the homogeneity of firms’ classification choices within an industry.
Our third information environment variable pertains to U.S. cross-listing. Bradshaw et al. (2004) argue that cross-listed firms have stronger incentives to make similar reporting choices as U.S. companies. Empirically, their data show a positive correlation between U.S. GAAP conformity and cross-listing. Therefore we expect that cross-listed firms will be less likely payday loans in Springfield to classify items such as interest paid in financing, which is not allowed under U.S. GAAP.
Evidence also suggests that analysts’ cash flow forecasts create capital market incentives to report higher OCF (DeFond and Hung 2003; Brown et al
We include firm size to capture financial reporting incentives, financial reporting expertise, and the financial reporting environment of large versus small firms. We do not have a prediction for its sign. Finally, we include indicator variables for country and industry. The regression model is as follows:
= operating cash flows as reported by the firm for year t less operating cash flows for year t adjusted to include interest paid, interest received, and dividends received in operating cash flows if these items are not already reported in the operating section, averaged over the sample period;
= one if the firm classifies interest paid in financing cash flows as of the last year reported and zero otherwise;
= one if the firm’s financial distress computed using Altman’s Z-score is less than 1.81, indicative of high distress, and zero otherwise;