An empirical investigation of the relative strength of association between market reaction and certain measures of income and funds flows to the enterprise

In recent pronouncements, the Financial Accounting Standards Board has emphasized the importance of funds flows and has suggested expanded disclosure of funds flows in financial statements. The purpose of this research study was to examine the relative importance of earnings versus funds flows by evaluating the association between market reaction and three measures of income versus the association between market reaction and six measures of funds flows to the enterprise. The contemporaneous association between market reaction and each variable was assessed at the earnings announcement date of each firm in the sample for the years 1972 through 1979.

The methodology involved classifying market reaction as "good news," "bad news," or "indifference" by using daily returns in the market model. The announcement of each variable was similarly classified by using two distinct models. The Cramer statistic was used as the measure of the level of association between the categories of market reaction and the categories for each variable announcement. Each variable was also ranked according to its association with market reaction as measured by the Cramer statistic.

Even though the rankings were not very consistent between years, certain trends were noted. As a group, earnings were ranked higher than funds flows. Within the earnings group, no variable was consistently ranked higher than other earnings variables. Within the funds flow group, net change in cash tended to be ranked higher than other funds flow variables. Total funds provided by operations was also ranked high among the funds flow variables.