Value Relevance of Earnings News, Accruals News, and Cash Flows News: Variance Decomposition Analysis

This study examines the value relevance of earnings news, accruals news, and cash flows news in driving the stock returns of the firms listed in Korea Stock Exchange (KRX) for the period 1994 through 2010. Using the variance decomposition (VD) framework (Vuolteenaho 2002), this study addresses the bias arising from constant discount rate assumption, which is unavoidable in the standard regression model used by most value relevance studies since Ball and Brown(1968) and Beaver(1968). Consistent with Vuolteenaho(2002), we find that earnings news explains the variance of stock returns better than the expected return news. Following Callen and Segal (2004), we further disaggregate earnings news into cash flows news and accruals news. We discover that cash flows news dominates accrual news in explaining the variability of excess stock return. Interestingly, our finding is the opposite of the results from the US stock market in Callen and Segal(2004). This finding suggests that cash flows are more value-relevant than accruals in countries where accounting transparency is low, the result possibly contributing to international value relevance literature. Our results are robust to various firm characteristics such as the level of stock returns, firm size, operating cycle, and industry classification.