Earnings Quality and the Joint Issuance of Analyst Earnings and Cash Flow Forecasts

This study investigates the effect of earnings quality on the financial analysts' propensity to jointly issue cash flow and earnings forecasts in Korea. Prior research reports that financial analysts issue more cash flow forecasts when absolute total accruals are high, which they attribute to higher investor demand for cash flow forecasts to help interpret the information contained in earnings when earnings quality is low. On the contrary, Bilinski (2013) argues that when cash flow forecasts become increasingly inaccurate compared to earnings estimates when earnings quality is low, their usefulness to investors decreases. Thus, we hypothesize that analysts are less likely to issue cash flow forecasts for firms with low earnings quality. Following Bilinski (2013), we use the variation in discretionary current accruals (McNichols, 2002) as our main earnings quality measure and also use all one-year ahead annual EPS estimates and the accompanying cash flow forecasts for Korean firms over the fiscal years 2006-2011. We find that the analyst propensity to jointly issue cash flow and earnings forecasts has a positive association with the variation in discretionary current accruals, rejecting our hypothesis. It means that analysts are more likely to jointly issue cash flow and earnings forecasts when earnings quality is low in Korea. Our finding is consistent with the notion that cash flows are incrementally useful to earnings in security valuation mainly when earnings quality is low. This study contributes to accounting research as it directly tests the association between the analyst propensity to jointly issue cash flow and earnings forecasts and the earnings quality in Korea, providing empirical support that low earnings quality increases the analyst propensity to report a cash flow forecast to complement the earnings estimate. The limitation of our study is that we might have omitted other variables and might not have fully considered other proxies for the earnings quality.