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WHICH IS MORE VALUE RELEVANT: EARNINGS OR CASH FLOWS?

A LIFE CYCLE EXAMINATION

Ervin L. Black

Department of Accounting

University of Arkansas

Fayetteville, AR 72701

Telephone: (501) 575-6118

Fax Number: (501) 575-7687

[email protected]

May 1998

*This paper benefited from funding by the Cox Fellowship and the University of Washington AccountingDevelopment Fund. I am grateful for comments on earlier drafts of the paper from dissertation committee members:Gary C. Biddle, Terry J. Shevlin, Edward Rice and Susan B. Moyer; seminar participants at the University ofArkansas, Michigan State University, University of Wyoming and Texas Christian University; and from HelenAdams, Robert Bowen, David Burgstahler, Kevin Harper, Alister Hunt, Lauren Kelly, Karen Pincus, D. Shores, andKenton Walker.


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ABSTRACT: Statements in the financial press and recent research suggest that controversyexists as to which accounting measure is more value-relevant: earnings or cash flows. This study

examines the relative value-relevance of earnings and cash flow measures in different life-cycle

stages. Earnings are predicted to be more value-relevant in mature stages. Cash flows are

expected to be more value relevant in stages characterized by growth and/or uncertainty. In

general the hypotheses are supported using WaldX2tests (Biddle, Seow, and Siegel 1995) of a

model based on the theoretical work of Feltham and Ohson (1995). Evidence supports the

hypothesis that earnings are more value-relevant than operating, investing, or financing cash

flows in mature life-cycle stages. However, in the start-up stage investing cash flows are more

value relevant than earnings. In growth and decline stages, operating cash flows are more value

relevant than earnings.


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According to U. S. financial accounting standards and prior research, accrual-based

earnings provide a better measure of firm performance than cash flow information. FASB

Statement of Concepts No.1, paragraph 44, states: "information about enterprise earnings and its

components measured by accrual accounting generally provides a better indication of enterprise

performance than does information about current cash receipts and payments." Results from

prior capital markets research imply that earnings are more value-relevant than operating cash

flows (Dechow 1994; Biddle, Seow, and Siegel 1995; Rayburn 1986; Sloan 1996).

However, an alternative view of accrual accounting is often expressed in the business

press as illustrated in theInstitutional Investor (August 1988, p. 55), "a growing number of

portfolio managers and analysts insist that cash flows is a more meaningful measure of a

company's value than reported earnings."Institutional Investor(1994) reports that 61.8 percent

of chief financial officers make maximizing cash flow a top priority compared with 54 percent in

a prior study.1 Also, even though Biddle, Seow, and Siegel (1995) find that in the majority of

industries earnings is more value relevant than operating cash flows, in some industries operating

cash flows is more value-relevant than earnings. Thus, there continues to be controversy as to

which is more value relevant: earnings or cash flow measures.

Prior research has not examined the effects of the corporate life cycle on the relative

value-relevance of accounting performance measures. Bernard (1989) observes that, the

primary deficiency of the existing [valuation] literature is that too little thought has been given to


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what economic message could be conveyed by a given disclosure, and how that message may

vary across situations. He also implies that a firms life-cycle stage could affect the value-

relevance of accounting disclosures when he states that it would be interesting to study how

fundamental analysis for new firms differs from that for established firms. The Institute of

Managerial Accountants (1986, p. 13) says that, at each stage...in an entity's life-cycle, different

measures of financial performance take on varying degrees of importance. Therefore, neither

growth nor net income nor cash flows nor return on investment [for example] should be

emphasized to the exclusion of other meaningful measures.

This paper addresses deficiencies of prior valuation/information content studies by

addressing the question of whether earnings is more value relevant than cash flow measures in

all firm life-cycle stages. The firm life cycle offers a key setting for analysis of the relative

value-relevance of earnings and cash flow measures. The life-cycle concept captures a common

set of financial characteristics for firms in a life-cycle stage and is used frequently in academic

research and the financial press. Because a number of financial characteristics differ by life-

cycle stage, it follows that the relative value-relevance of accounting measures may not be the

same in each life-cycle stage. For example, cash flows may be more value-relevant than

earnings for firms in decline. CA Magazine,(1993) p. 18-19, states that cash flow is a better

measure of a companys recovery following a recession than are book profits. Also, one of the

main reasons cited for business failures, especially for small start-up/emerging growth

companies, is poor cash management, not lack of profits (Small Business Reports 1991).

Hypotheses are developed which predict the relative value-relevance of the cash flow

measures and earnings for firms in different life-cycle stages. These relationships are based on a


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model of the components of firm value (Myers 1977). Financial characteristics associated with

corporate life-cycle stages are used to classify firm-years into life-cycle stages. The relative

value-relevance of earnings and three cash flow measures are tested cross-sectionally in life-

cycle stage using methods developed in Biddle, Seow and Siegel (1995). Data are collected

from various sources, including the CompustatAnnual Industrial and the Annual Research data

sources.

As hypothesized earnings exhibit the strongest value-relevance for firms in mature stages.

In the early and later life-cycle stages, a cash flow measure (investing cash flows in the startup

and operating cash flows in the growth and decline stages) is more value-relevant than earnings.

The results imply that for mature firms, earnings is a better summary measure than cash flows.

But, in other life-cycle stages cash flow measures are better summary measures for valuation.

Related Research on Life-Cycle Theory and Value-Relevance

Corporate life-cycle theory is an extension of the product life-cycle concept developed in

marketing and microeconomics (Rink and Swan 1979 and Mueller 1972). Individual products

(goods or services) move through four more or less identifiable phases: start-up, growth, mature,

and decline. Similarly, firms can be described as having life-cycle stages that depend on their

portfolios of products. Models of the firm life cycle presuppose that there are regularities in

corporate development and that these regularities occur in such a way that the corporations'

developmental processes lend themselves to segmentation into stages or periods of time (Smith,

Mitchell, and Summer 1985).

Life-cycle stages are frequently used in the financial press and in investment research to

describe firms. Secured Lender (1994), Network World (1994), Journal of Management (1994),


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and Journal of Business Venturing (1994) provide evidence that businesses, investors,

academics, and lenders use the life-cycle concept in their evaluations of firms. For example, the

Secured Lender(1994,page 38) states that, an awareness of the clients specific growth stage

and an understanding of where the firm has been and how it got there will help [lending

institutions] better evaluate the firms financial information, current and future needs, and

management capabilities. Also, various mutual fund companies have emerging growth or

growth funds composed of firms that are primarily in the growth stage of the life-cycle.

Prior research has not examined the effects of the corporate life cycle on the relative

value-relevance of accounting performance measures. However, recent studies that examined

the relative value-relevance of earnings and operating cash flows contain results that might be

clarified by considering the corporate life cycle. For example, Dechow (1994) provides evidence

that earnings are more value-relevant than operating cash flows (1) the shorter the performance

measurement interval, (2) the greater the volatility of the firms working capital requirements

and investment and financing activities, and (3) the longer the firms operating cycle. Her

hypotheses are primarily based on the premise that cash flows are predicted to be more arbitrary

and suffer more severely from timing and matching problems than earnings. This may be true

for firms that are in the mature stage, but for firms that are in start-up, growth or decline,

earnings also suffer from these problems.

As another example, Biddle, Seow, and Siegel (1995) examine the relative value-

relevance of earnings, operating cash flows (CFO), and sales in different industries. They

provide evidence that for most industries earnings are most value-relevant, but for some

industries CFO is most value-relevant. While they did not attempt to control for industry life-


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cycle, these results could be affected by the life-cycle stage of firms in a particular industry. As

predicted by the hypotheses, cash flow measures of firms in industries with the majority of firms

in start-up, growth, or decline stages may be expected to be more value-relevant than earnings.

Moreover, there is some evidence of a life-cycle effect related to accounting measures

other than earnings and cash flow measures. Anthony and Ramesh (1992) show that stock

market response to unexpected sales growth and unexpected capital investment is a function of

firm life-cycle stage, even after controlling for firm size, risk, and measurement error in the

proxies of the performance measures. Black (1998) finds evidence of life-cycle impacts on the

incremental information content of earnings and cash flow measures. Selling and Stickney

(1989), in an examination of business environment effects on a firm's return on assets, find

evidence that industry characteristics, including industry life-cycle, are useful in understanding

return on assets (ROA) over time and across firms. For example, industries with the highest

ROAs are all mature, whereas, industries with the lowest ROAs are either in the decline phase or

highly cyclical.

This study combines these life cycle and value-relevance research streams to examine the

effect of the corporate life cycle on the value-relevance of accrual-based earnings and the three

summary cash flow measures (FAS 95). In the next section hypotheses are developed which

predict different relative value-relevance relationships for earnings and cash flow measures in

different life-cycle stages.

Life Cycle Effects on the Relative Value-Relevance of Accounting Measures

Life Cycle Effects

Consider the characterization of firm value provided by Myers (1977):


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Value of Firm = Value of Assets in Place + Value of Growth Opportunities (1)

The relative value of assets in place compared to the value of growth opportunities changes as a

firm proceeds through its life-cycle. For example, start-up firm value is largely a function of the

value of growth opportunities, whereas a mature firm has relatively fewer growth opportunities

and its value is largely attributable to the value of assets in place.

Myers characterization of firm value is closely related to a valuation model (used by

Burgstahler and Dichev 1997 and Barth, Beaver and Landsman 1996) which expresses, in

general form, market value of equity,MVE, for firm iin year t,as a linear function of recognized

net assets (assets in place) measured by book value of equity -BVE, and unrecognized net

assets (growth opportunities), UNA:

MVEit= a1BVEit+ a2UNAit (2)

If book values of recognized assets equal their fair values and fair values are well-defined as in a

setting economically equivalent to perfect and complete markets, UNAequals the present value

of incremental cash flows of unrecognized net assets (growth opportunities), and a1and a2each

equal one. If book values do not equal their fair values, then UNAalso includes the difference

between fair and book values of recognized net assets; i.e., it would include the value of the

growth opportunities and the difference between fair and book values of assets. In the more

realistic setting of imperfect and incomplete markets, UNAreflects the difference between

assets values-in-use over entry or exit values, and a1and a2need not equal one.

Because revenues and expenses relating to unrecognized net assets, including any excess

of values-in-use over entry or exit values, can be reflected in net income (NI), net income is a

proxy for UNA (see Bernard 1994; Barth and Landsman 1995, and Ohlson 1995). Depending on


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a firms life-cycle stage other potential proxies of a firms unrecognized net assets are the three

summary cash flow measures: operating cash flows (CFO), investing cash flows (CFI), and

financing cash flows (CFF).

The value-relevant information provided by a given accounting measure can be

envisioned in a Venn diagram. Relative value-relevance tests compare the size of the circles to

determine which is the largest.2 To empirically implement equation (2), the following

estimating equation is used:

MVEit= a0 + a2BVEit+ a2UNAit+ eit. (3)

Hypotheses are tested by comparing the value-relevance, in each life-cycle stage, of four

different proxies of UNA:NI, CFO, CFI, and CFI.

In his text, Stickney (1996, p. 46) shows the expected relation of income flows and cash

flows from operations, investing, and financing at various life-cycle stages. White, Sondhi, and

Fried (1997, pp. 187-188) describe life-cycle effects on the firms financial performance and the

expected pattern of ratios in different life-cycle stages.

Hypothesis Development: Life-cycle Effects on Relative Value-Relevance

In early firm life-cycle stages, growth opportunities are a relatively larger component of

firm value than assets in place. Assets in place, in these early stages, are expected to provide less

value relevant information about firm value, because they are a relatively smaller component of

firm value. In the start-up and early growth stages, book value of equity is expected to more

closely approximate the liquidation value of assets in place; i.e., current cost is not too removed

from historical cost. Thus, in these stages, the proxy that provides more value-relevant


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information about firm-value is the one that provides more information about the future growth

opportunities of the firm.

Cheung, Liu, and Schaefer (1996) find that the value-relevance of earnings decreases,

and the value-relevance of operating cash flows increases, with a decrease in the permanence of

earnings. In start-up and early growth stages, the revenue and expenses generated by a firms

assets in place are expected to be more transitory than in later growth or mature stages, when

income is more predictable. An example of this can be seen in the biotechnology or electronics

industry when assets in place, used for development of products and research early in the firm

life-cycle, generate few, if any, revenues, and income is negative. As these companies mature

the nature of the revenues and expenses change to include more production and sales related

activities, which become more predictable, and permanent, as the firm matures.

Many firms fail during the early life-cycle stages for reasons related to cash flows. The

cash flow measures are expected to provide information about the viability of the firm - whether

the firm survives to realize its growth opportunities. Financing cash flows provide value-

relevant information about the ability of the firm to obtain financing to fund growth and

development. Investing cash flows provide value relevant information about investment in long-

term assets to develop growth opportunities or unrealized net assets, UNA. Operating cash flows

provide information about the firms ability to internally fund growth. Thus, the first hypothesis

is (in alternative form):

H1: During early life-cycle stages, cash flow measures are expected to be more value-

relevant than earnings.


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As the firm matures, growth opportunities, although still a major component of firm

value, are relatively lower and the relative value of assets in place increases. Assets in place

generate revenues and expenses which are more representative of the value-in-use, than in more

early life-cycle stages. Also, the revenues and expenses generated by the assets in place are

more value-relevant about the value of growth opportunities or UNA. More of the firms

unrecognized net assets, or growth opportunities, are expected to be similar to its assets in place

as firm expansion occurs in areas of business similar to its current business. Also, the firms

ability to profitably take advantage of growth opportunities is better known as the firm develops

a track record.

In these later growth and mature stages, earnings are expected to be less transitory and

more permanent. The clean surplus assumptions of the Feltham-Ohlson (1995) model are more

likely to hold; thus, net income is also expected to better approximate UNA than in early or later

life-cycle stages. Thus, in these stages, earnings are expected to provide more value-relevant

information than cash flow measures, which yields the second hypothesis (in alternative form):

H2: During mature life-cycle stages, earnings are expected to be more value-relevant

than cash flow measures.

In later, declining life-cycle stages the permanence of a firms earnings is expected to

decline as the change in earnings is expected to be larger and negative for declining firms.

Cheng, et.al., find evidence that supports the increased value-relevance of operating cash flows

relative to earnings as the permanence of earnings declines. Barth, Beaver, and Landsman

(1996) find that the value-relevance of net income is lower than book value of equity for firms

with poor financial health relative to other firms. Subramanyan and Wild (1993) find that the


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informativeness of earnings is inversely related to proxies for probability of liquidation or

financial difficulty. Thus, evidence suggests that earnings ability to convey value-relevant

information about the firms unrecognized assets and/or the values-in-use over entry or exit

values is lower when a firm is in decline.

In contrast, cash flow measures are expected to provide value relevant information about

the firms growth opportunities, or lack thereof. Operating cash flows provide information about

the firms ability to continue to cover cash needs internally. Investing cash flows provide

information about the liquidation value of a firms existing assets and about its capital

expenditures. Financing cash flows provide value-relevant information about the firms

financing activities, including its ability to borrow or repay debt and raise equity capital. Thus,

the third hypothesis, in alternative form, is:

H3: During declining life-cycle stages, cash flow measures are expected to be more

value-relevant than earnings.

Research Methodology

Life-cycle stage classification

This study reports results based on life-cycle classification methods developed by Anthony and

Ramesh (1992). Anthony and Ramesh classify firms using individual variables (dividend

payout, sales growth, and firm age) and then use a composite score obtained from all variables

for classification. They assign firm-year observations into Low, Medium, or High categories for

each of the three classification variables. Then, these rankings are assigned a score (1, 2, or 3).

For each firm-year observation scores are then added to form a composite score and the

observations are categorized into five life-cycle stages and assigned to groups such that an


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approximately equal number of observations are in each group: Growth, Growth/Mature, Mature,

Mature/Decline, and Decline. In this paper, a start-up stage is also added composed of a smaller

set of firm-years.3 The criteria for a start-up firm-year observation are the following:

1. Firm was founded between 1976 and 1994.2. Firm was not formed as a result of a divestiture, merger, or other form of restructuring.3. Firm had no more than one year of sales history prior to going public.4. Only the first three years of firm data are included after the founding date.

These firms, in their first three years, are classified as start-up firm-years. This classification

assumes that the firm does not move into the growth stage any sooner than three years from

inception. Relative value-relevance tests of the hypotheses are performed in each of six life-

cycle stage portfolios.

Sample Selection

Data are obtained from Compustat(Annual and Research) 1976-1995 data sources for the

financial statement variables and market values. Data for firm age is obtained fromMoodys

Industrial Manual. The sample is restricted to firms for which life-cycle classification data and

cash flow and earnings data are available. Utilities, insurance, and financial institutions are not

included in the study, due to their unique characteristics as regulated industries. The requirement

for life-cycle classification data resulted in a potential sample size of 78,813 total firm-year

observations. Required data for regression variables further reduced the sample to 37,961 firm-

year observations:

192 Start-up observations 7,162 Growth observations


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7,350 Growth/Mature observations 6,169 Mature observations 8,514 Mature/Decline observations 8,574 Decline observationsDescriptive statistics (medians) are given in Table 1 for the firm-year observations in

each of the life-cycle stages. These include the classification variables used in the multivariate

classification and other firm characteristics. These descriptive statistics indicate that the

classification method is successful, resulting in cross-sectional differences in firm characteristics

across life-cycle stages.

The start-upgroup has relatively low debt, negative earnings, operating cash flows, and

investing cash flows. Start-up firms are smaller and younger than firms in other life-cycle

groups, although their sales growth is high.

The growthportfolio of firm-years exhibits positive earnings, operating cash flows and

financing cash flows. The median growth firm pays few, if any dividends, investing cash flows

are negative, and its debt is higher than a start-up firm. By construction the sales growth and

capital expenditure ratios are largest for the growth portfolio and are lower in the other life-cycle

portfolios. Growth firms are still relatively small compared to the mature firms.

Firms in the growth/mature and matureportfolios are much larger and pay more

dividends than in the earlier and later stages; debt is relatively high; net income and operating

cash flows are positive, and investing and financing cash flows are negative.

Firms in mature/declineand declinehave lower earnings and operating cash flows

(negative for decline firms); they are smaller, have less debt, have few financing cash flows or

investing cash flows, and pay few dividends.


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Table 2shows the industry composition of each of the life-cycle stage portfolios and

Table 3gives the number of firm-year observations by year for each of the life-cycle stages.

From these tables it appears that there is some clustering of industry and years in the life-cycle

stage portfolios. Clustering by industry is to be expected, because industries also have life-

cycles that affect the firm life-cycle. Macroeconomic effects (business cycles) are also related to

firm life-cycle and cause time clustering. However, the fact that firms start-up, for example,

when economic conditions are favorable, or in promising industries, should not affect the relative

value-relevance tests of accounting performance measures as long as these omitted variables are

not correlated with the variables of interest.

To substantiate the classification methodology and to make sure that random economic

effects are not creating misclassification, a check is made on the stability of the firm-year

classifications. If a firm-year observation is classified in a life-cycle stage portfolio, an

examination is done one and two years prior to and after the year of classification to see in which

life-cycle stage the firm is classified in those years.

The start-up group, by construction, has no firm-year observations classified in other

stages prior to the classification year. 60% of firms that are classified as start-up remained in the

start-up group from one year to the next. Two years after being included in the start-up portfolio

79% of these firms are no longer in the start-up portfolio; 26% of the start-up firms are in the

growth stage, none are in the mature stage, 31% are in the decline stage. The remainder of the

start-up firms is not classified in a life-cycle stage portfolio within two years after being included

in the start-up portfolio.


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A similar check of the other life-cycle stages indicates stability. For firm-years classified

as growthfirms in any year 51% are in the growth stage two years prior and 54% remained in the

growth portfolio two years after being included in the growth portfolio. 67% of the maturefirm-

years are in the mature stage two years prior to being included in the mature portfolio and two

years after inclusion 70% are still in the mature phase. 49% of the declinefirm-years are in the

decline stage two years prior to being included in the decline portfolio and two years after

inclusion 64% are still in the decline phase.

In Table 4,Pearson correlations of the regression coefficients are given. In the start-up

stage there is some evidence of the collinearity of NI and CFO, as well as CFF with CFO and

CFI. In the other life-cycle stages all of the variables are significantly correlated with each other.

This indicates that these variables measure some of the same value relevant factors. The

empirical tests are designed to determine which accounting performance measure is most value

relevant in a particular life-cycle stage, regardless of overlap in information provided with other

measures.

Empirical Tests

Tests of the relative value-relevance hypotheses are performed using Wald tests on the

significance of the squared coefficients. Biddle, Seow, and Siegel (1995) develop a

methodology for the problem of testing whether one subset of predictor variables is significantly

more explanatory than another subset. This methodology is appropriate asymptotically when the

disturbances could be heteroskedastic and assumes that the error terms,_i, from equations (4a-c)

are vectors of unobserved random disturbances that are normally distributed with mean zero and

unknown covariance matrix. Two different matrices represent subsets of predictor variables;


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each consists of a subset of columns of the independent variables. The object is to test whether

one subset of predictor variables is significantly better than the other for the purpose of

explaining the dependent variable, MVE.

MVEit= 0+ 1BVEit + 2NIit+ 3CFOit+_ 1it (4a)

MVEit= 0+ 1BVEit + 2NIit+ 3CFIit+ _ 2it (4b)

MVEit= 0+ 1BVEit + 2NIit+ 3CFFit+_ 3it (4c)

where,MVE= the market value of equity for firm iat time t.

NI = earnings before extraordinary items for firm iat time t.

CFO= cash flow from operating activities for firm iat time t.

CFI = cash flow from investing activities for firm iat time t.

CFF = cash flow from financing activities for firm iat time t.


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Null hypotheses for the relative value-relevance hypotheses become:

Null Hypotheses SUBSET 1 SUBSET 2 EQUATION

NI =RCFO NI CFO 4a

NI =RCFI NI CFF 4b

NI =RCFF NI CFI 4c

where, the sign, =R, signifies that each of the subsets of variables is equally value-relevant.

In general when comparing the quality of two sets of predictors, X1and X2 , the matrix Y1

consists of the columns of X that are not in X1 , and similarly for Y2. B1and B2are subsets (1

and 2, above) of regression coefficients for Y1and Y2,, respectively. Thus, the null hypothesis

becomes in general form: (equation 3.1 from Siegel & Biddle 1994)

HO: B1Y1[In- X1(X1X1)-1X1]Y1B1 = B2Y2[In- X2(X2X2)

-1X2]Y2B2 (5)

This nonlinear hypothesis is of quadratic form in the regression coefficients. The left-

hand side of the hypothesis represents the bias due to omitting Y1from the regression, keeping

only X1, which is a quadratic form in the omitted regression coefficients B1. The right-hand side

represents the bias when Y2 is omitted. The test result is then computed using the estimated

coefficients and their heteroskedasticity-adjusted variance-covariance matrix. Siegel and Biddle

show that the Wald test is asymptotically valid and is appropriate when specific hypotheses are

prespecified: as is the case in this paper. Appendix Ashows the derivation of each of the tests

of the relative value-relevance tests of the null hypotheses. These tests are performed for

portfolios of firm-year observations that qualify for inclusion in one of the four life-cycle stages

(start-up, growth, mature, and decline) and two transition stages (growth/mature and

mature/decline).


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Results

Results of the relative value-relevance tests are found in Tables 5 - 10. In general, the

hypotheses are supported. The results provide evidence that cash flow measures are more value-

relevant than earnings in start-up, growth, and decline stages. Earnings are more value relevant

in mature stages.

In the start-upstage, the hypotheses predict that the cash flow measures are more value-

relevant than earnings. Evidence provided in Table 5 supports the hypothesis that investing cash

flows are more value relevant than earnings for start-up firms. In the regression of equation 4b,

CFI is the only significant independent variable and the WaldX2statistic is significant. The Wald

X2statistic measures whether the information provided by one variable is significantly different

from that provided by another. It does not, however, tell which measure has greater information.

To do this, the R2statistic is needed for regressions of equation 3, substituting the different

independent variables for UNA. Table 5, Panel B, R2statistics from regressions of equation 3

provide evidence that CFI (R2= 0.33) is more value-relevant than earnings (R2= 0.12). Neither

operating nor financing cash flows is significantly more value-relevant than earnings, although

the R2statistics are higher for these variables than for earnings.

In the growthstage, the hypotheses predict that the cash flow measures are more value-

relevant than earnings. Results for this stage are provided in Table 6. The results support the

hypothesis that operating cash flows are more value relevant than earnings for growth firms. In

the regression of equation 4a, CFO and BVE are incrementally significant, but not NI. The Wald

X2statistic is significant. The R2statistics in Table 6, Panel B provide evidence that CFO (R2=


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0.80) is more value-relevant than earnings (R2= 0.77). Neither investing nor financing cash

flows is significantly more value-relevant than earnings.

The hypotheses predict that earnings are more value-relevant than cash flow measures in

the growth/maturestage. Results for this stage are provided in Table 7. The results provide

evidence that earnings are more value-relevant than each of the cash flow measures for

growth/mature firms. In the regression of equations 4a-c, NI is significant in each of the

regressions. The operating and financing cash flow measures are only marginally significant,

and investing cash flows are not significant. WaldX2statistics are significant in each of the

regressions. The R2statistics in Table 7, Panel B provide evidence that NI (R2= 0.80) is more

value-relevant than CFO (R2= 0.75), CFI (R2= 0.75), or CFF (R2= 0.74).


the maturestage. The results, Table 8, provide evidence that earnings are more value-relevant

than each of the cash flow measures for mature firms. NI is significant in each of the regressions

of equations 4a-c. Operating and investing cash flow measures are incrementally significant, but

financing cash flows are only marginally significant. WaldX2statistics are significant in each of

the regressions. The R2statistics in Table 8, Panel B provide evidence that NI (R2= 0.87) is

more value-relevant than CFO (R2= 0.82), CFI (R2= 0.81), or CFF (R2= 0.79).


the mature/declinestage. However, results, shown in Table 9, provide evidence that operating

cash flows are more value-relevant than earnings. Earnings, also, do not appear to be more

value-relevant than investing or financing cash flow measures for mature/decline firms. NI is

incrementally significant only in the regression of equation 4a. Operating and investing cash


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flow measures are incrementally significant, but financing cash flows are not significant. Wald

X2statistics are significant only in equation 4a. The R2statistics in Table 9, Panel B provide

evidence that CFO (R2= 0.80) is more value-relevant than NI (R2= 0.76). For CFI (R2= 0.78)

and CFF (R2= 0.76) the evidence suggests that the value-relevance of these measures of cash

flow is at least as good as the value-relevance of earnings for firms in the mature/decline stage.

In the declinestage, the hypotheses predict that cash flow measures are more value-

relevant than earnings. Table 10 provides results that support the hypothesis that operating cash

flows are more value-relevant than earnings. CFO, but not NI, is incrementally significant in the

regression of equation 4a. WaldX2statistics are significant only in equation 4a. The R2statistics

in Table 10, Panel B provide evidence that CFO (R2= 0.48) is more value-relevant than NI (R2=

0.39). For CFI (R2= 0.38) and CFF (R2= 0.37) the evidence suggests that the value-relevance

of these measures of cash flow is no better than the value-relevance of earnings for firms in the

decline stage.

Although not tested directly, the explanatory power of the models appear to be much

better in the growth, growth/mature, mature, and mature/decline stages. The R2statistics of the

regressions in these stages was on the order of 0.80, while in the start-up and decline stages the

R2statistics are much lower (0.12 to 0.33 for start-up and 0.37 to 0.48 for decline portfolios).

From these results it seems that information other than earnings and cash flows is being used to

determine market values, e.g., intangibles, human capital, probability of bankruptcy, etc.

There is also evidence that the size of the coefficients is different depending on the life-

cycle stage. The earnings coefficient in the growth/mature and mature stages are much larger

than in other life-cycle stages. These mature stages are also the stages when earnings dominate


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the cash flow measures. In the other stages (start-up, growth, and decline), the earnings

coefficient is very small and earnings do not tend to be significant in the regressions.


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Conclusions and Implications

Much of the valuation/information content research in accounting has been devoted to

verifying the value-relevance/informativeness of earnings beyond the more primitive cash flow

measures, particularly operating cash flows. This study examines the relative value-relevance of

not only earnings and operating cash flows, but also examines investing and financing cash

flows. Also, by examining the effects of the corporate life-cycle on these relationships, this

study is able to provide evidence of the value-relevance of earnings and cash flow measures in

the economic context of life-cycle theory. The results of this study suggest that life-cycle stages

influence the value-relevance of earnings and cash flow measures.

The results provide evidence that earnings are more useful than cash flow measures only

in the growth/mature and mature stages. The relative value-relevance test results provide

evidence that the accrual process, which yields earnings, gives more value-relevant information

than operating cash flows in the growth/mature and mature life-cycle stages. Earnings are also

more value-relevant than investing and financing cash flows in these two stages. Only about

one-third of the observations are in this stage.

For firms in early and later life cycle stages (about two-thirds of the observations), cash

flow measures are more value relevant, although the particular cash flow measure differs.

Investing cash flows are more value-relevant than earnings in the start-up stage, and operating

cash flows are more value relevant than earnings in the growth, mature/decline, and decline

stages. In start-up, growth, mature/decline, and decline life-cycle stages, the evidence suggests

that cash flow measures are at least as value-relevant as earnings, which supports the usefulness

of the cash flow statement, provided for in FAS 95. This evidence implies that in the early and


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23

later life-cycle stages of the firm earnings may not be the summary measure that investors and

creditors should focus on. Earnings do not dominate the cash flow measures in these early and

later stages when growth is occurring or when the long-term viability of the firm is in question.

Implications of this study apply to researchers, analysts, educators, and firm

management. Results will be weaker, and may lead to inaccurate conclusions, if researchers on

the value-relevance of accounting and non-accounting disclosures assume that these disclosures

are equally value-relevant in all life-cycle stages. Analysts need to be aware of the changing

value-relevance of these and other accounting measures throughout the life cycle. Educators and

most textbooks, in general discuss the statement of cash flows last and do not give it the

emphasis that it needs given the results of this study. Also, firm management need not focus, nor

be evaluated, on earnings as the most value-relevant accounting number in all life-cycle stages of

the firm.

A subject for future study is the examination of the value-relevance of other accounting

variables in life-cycle stages, particularly for start-up and decline firms, when the R2statistics are

much lower. This study provides evidence that accounting performance measures (earnings and

cash flow variables) have limited usefulness in these stages. Therefore, other accounting

variables can be examined for informativeness, such as research and development expenditures

and other intangibles, such as access to technology and human capital. A call has been made for

this line of research (Lev 1997). Examining firms in these early and late life-cycle stages can

enhance the potential for powerful results.


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ENDNOTES

1Other examples in the business press include: Cash is king, Small Business Reports1991, pp.48-56; Cash is king for corporate Japan,Business Week1995, p. 37; Where cash flow is

king, The Economist1995, p. 80.

2Incremental value-relevance is concerned with the overlap of the circles. For example, if theinformation from earnings is in circle A, and the information from one of the cash flow measures

is in circle B, circles A and B can overlap to some extent and both may be incremental to the

other unless the circles are coincidental. But, tests of incremental informativeness or value-

relevance do not test for which circle is larger the other. For a more extensive discussion on

relative vs. incremental information content see Biddle, Seow, and Siegel (1995).

3Despite the fact that the great majority of firms on Compustat andCRSPare in later life-cycle

stages, a sample of 192 firm-years is obtained for the start-up group. Mikkelson and Shah

(1993) in a study of IPO firms, found a substantial number of firms (52) during the 1980 - 83time period, which had gone public, had data available on Compustat, and had no more than one

year of sales history. They provided me with a listing of these firms. I have also been able to

use an IPO database provided by Jay Ritter to get some of the stock return data for these firms.

Data from these sources are supplemented with data obtained from Compustat, CRSP,Moodys

Industrialmanual, and annual reports to complete the data requirements for firms, which meet

the criteria for start-ups. This group consists of over a hundred firms that have data on

Compustat or in annual reports.


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Dechow, P., Accounting earnings and cash flows as measures of firm performance: The role of

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Gardner, L.A., Opportunities and pitfalls in financing during business growth, SecuredLender50, Issue 3, 1994, 38-42.

Institute of Managerial Accountants, Statements on management accounting, Statement no. 4D,

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Lant, J., Cash is king, Small Business Reports(May 1991), 48-56.

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of Management 20, 1994, 795-833.

Siegel, A.F. and G.C. Biddle, Comparison of regression functions in the presence ofheteroskedasticity, 1994, Working Paper, University of Washington.

Sloan, R.G., Do stock prices fully reflect information in accruals and cash flows about future

earnings?, The Accounting Review71, 1996, 289-315.

Smith, K.G., T.R. Mitchell, and C.E. Summer, Top level management priorities in different

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Stickney, C.P, Financial Statement Analysis A Strategic Perspective,1996, Third Edition,

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Subramanyam, K.R., and J.J. Wild, The going concern assumption and the informativeness of

earnings, 1993, Working Paper, University of Wisconsin, Madison, WI.

Where cash flow is king, The Economist,334 (February 18, 1985), 80.

White, G.I., A.C. Sondhi, and D.Fried, The Analysis and Use of Financial Statements,1997,

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Table 1

Descriptive Statistics by Life-Cycle Stage (Medians)

# Observations 192 7,162 7,350 6,169 8,514 8,574

Variable Start-up Growth Growth/

Mature

Mature Mature/

Decline

Decline

Market Value of

Equity

16.52 21.95 164.19 208.47 24.64 10.91

Book Value of

Equity

3.40 12.16 115.13 128.84 13.73 4.41

Net Income -0.29 0.66 14.76 16.15 0.16 -0.52

Cash Flow from

Operations

-0.60 0.89 20.18 22.06 0.91 -0.02

Cash Flow fromInvesting -0.83 -3.88 -21.90 -19.37 -1.19 -0.163

Cash Flow from

Financing

1.93 1.86 -0.31 -1.57 0 0

Sales Growth (%) 27.21 38.32 12.30 8.29 6.16 -13.24

Capital

Expenditure Ratio

0.09 0.13 0.10 0.07 0.04 0.02

Capital

Expenditures

0.29 4.21 21.80 3.95 1.14 0.22

Dividend Payout

Ratio

0 0 0.33 0.36 0 0

Size

(Total Assets)

5.05 29.97 269.59 282.62 33.86 12.52

Debt to Equity

Ratio

0.06 0.42 0.57 0.49 0.30 0.16

Firm Age 2.36 16.48 24.43 33.51 38.64 43.65

Definition of Variables:

Market value of equity (in $millions), shares outstanding X fiscal year closing price (d25*d199).Book value of equity (in $millions), d60.Net income before extraordinary items and discontinued operations (in $millions), d18.

Cash flow from operating activities (in $millions), Compustat d308 for years 1987-1993;prior to 1987, CFO is calculated as:

d18 net income before extraord. items and discontinued operations+ d14 Depreciation and amortization (0 if missing)+ d5 Change in total current liabilities- d34 Change in current debt (0 if missing)- d4 Change in total current assets+ d1 Change in cash & cash equivalents (0 if #1 missing)+ d74 Change in balance sheet deferred taxes (#50, income

statement deferred taxes, if missing. 0 if both missing).


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Cash flow from financing activities (in $millions), Compustat d313 for years 1987-1993;prior to 1987, CFF is calculated as:

d9 Total long term debt+ d130 Preferred stock - carrying value (0 if missing)+ d85 Common Stock + d210 Capital Surplus- d127 Cash Dividends (0 if missing).

Cash flow from financing activities (in $millions), Compustat d313 for years 1987-1993;prior to 1987, CFI is calculated as:

Change in Cash (d162) - CFF - CFO.Sales Growth = [(SALESt- SALESt-1) / SALESt-1] X 100. (SALES = d12)Capital Expenditure Ratio = (CEt/Book Valuet) X 100. (CE = d128; VALUE = d60)Capital Expenditures (d128).Dividend Payout Ratio isDIVt/ NIt* 100, where,DIV = Annual Dividend (d127);NI = Annual NetIncome (d18).Size is total assets (in $millions), defined as Compustat d6.Debt to equity ratio defined as Compustat (d181 - d5)/d216.Firm Age is the age of the firm, computed as the difference between the current year and the year thebusiness was incorporated, except for the start-up sample, which is the difference between the current yearand the first year the company reported sales.


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Table 2

Industry Composition by Life-Cycle Stage

Industry Start-

up

Growth G/M Mature M/D Decline Total

00-09 Agriculture &

Const. Matl

0 41 30 36 56 61 224

10-14 Mining, Oil &

Gas

2 1452* 303 310 748* 216 3031

15-19 Construction 0 94 117 108 159* 108 586

20-22 Consumer

Goods & Food

0 238 689* 476* 211 585* 2199

23-25 Apparel 0 149 329 298 325 417* 1518

26-27 Business Sup.,

Printing, & Publishing

4 161 581* 408* 155 301 1610

28 Pharmaceuticals &

Chemicals

15 283 469 556* 823* 336 2482

29 - Oil and Gas

Refineries & Retail

0 31 195* 163* 21 60 470

30 Rubber & Plastic 2 162 242* 159* 133 108 806

31-33 Manufactured

Prods: Steel, Const.

Matl, & Clothing

6 191 421* 376* 218 686* 1898

34 Fabricated Prods 3 167 335* 283* 215 385* 1388

35 Machinery 29* 656 644 553 1012* 935* 3829

36 Electrical Eq. 12 789* 479 432 979* 749 3440

37 Autos, Rail, Ships

& Aircraft

7 163 339* 269* 184 265 1227

38-39 Medical,

Measurg & Control Eq

21 514 489 491 1114* 580 3209

50-59 Wholesale &

Retail

37 1157 1217 875 993 2237* 6516

70-89 Restaur.,

Lodging, Computers,Bus. & Pers. Services

52* 883* 465 374 1076* 541 3391

90-99 Other 2 31 6 2 92* 4 137

Totals by Life-Cycle

Stage 192 7162 7350 6169 8514 8574 37961

An asterisk (*) indicates a significantX2 where observations were significantly greater than the overall

distribution.


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Table 3

Firm-Year Observations for Each Year by Life-Cycle Stage

Year Start-up Growth Growth/

Mature

Mature Mature/

Decline

Decline Total by

Year1977 1 220 627* 346* 149 269 1612

1978 1 243 601* 296* 152 245 1538

1979 2 272 574* 304* 175 315 1642

1980 3 229 515* 383* 205 548* 1883

1981 11 439* 529* 344 260 424 2007

1982 26* 303 384 372 398 671* 2154

1983 32* 333 415 367 396 577* 2120

1984 26* 628* 510* 296 324 353 2137

1985 27* 338 333 353 497 554* 2102

1986 19* 348 298 309 491* 447 1912

1987 15 577* 359 305 482 341 2079

1988 13 494* 353 332 446 377 2015

1989 3 384 313 296 513 671* 2180

1990 4 434 308 317 512 707* 2282

1991 2 244 191 280 674* 872* 2263

1992 4 282 206 294 726* 813* 2325

1993 3 343 245 296 753* 109 1749

1994 0 564* 330 363 681* 147 2085

1995 0 487* 259 316 680* 134 1876

Total 192 7162 7350 6169 8514 8574 37961

An asterisk (*) indicates a significantX2 where observations were significantly greater than the overall

distribution.


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Table 4

Regression Variable Correlations by Life-Cycle Stage

A. Start-up

MV BVE NI CF CF

BVE 0.1

NI -0.05 -0.02

CFO -0.04 -0.04 0.2

CFI -0.2 -0.19 -0.03 -0.01

CFF 0.0 0.03 -0.13 -0.6 -0.3

B. Growth

MV BVE NI CF CFBVE 0.8

NI 0.6 0.6

CFO 0.7 0.7 0.6

CFI -0.61 -0.5 -0.2 0.3

CFF 0.3 0.3 0.05 -0.6 -0.8

C. Growth/Mature

MV BVE NI CF CF

BVE 0.8

NI 0.8 0.9

CFO 0.8 0.9 0.9

CFI -0.7 -0.8 -0.8 -0.3

CFF -0.2 -0.2 -0.2 -0.8 0.1

D. Mature

MV BVE NI CF CF

BVE 0.8

NI 0.9 0.9CFO 0.9 0.9 0.9

CFI -0.8 -0.8 -0.7 -0.8

CFF -0.1 -0.2 -0.2 -0.2 -0.2

Bold indicates significance at the 0.05 level.


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Table 4

Regression Variable Correlations by Life-Cycle Stage (continued)

E. Mature/Decline

MV BVE NI CF CF

BVE 0.8

NI -0.11 -0.1

CFO 0.7 0.7 -0.4

CFI -0.6 -0.6 0.15 -0.7

CFF 0.1 0.1 0.1 0.0 -0.6

F. Decline

MV BVE NI CF CF

BVE 0.6

NI 0.41 0.4

CFO 0.5 0.3 0.4

CFI -0.2 -0.1 -0.2 -0.4

CFF -0.0 -0.0 0.0 0.2 -0.61

Bold indicates significance at Th 0.05 level.


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Table 5

Results of Relative Value Relevance of Earnings and Cash Flows - START-UP

MVEit= 0+ 1BVEit + 2NIit+ 3CFOit+ _ 1it (4a)MVEit= 0+ 1BVEit + 2NIit+ 3CFIit+ _ 2it (4b)


Panel A: Regression Results

Equation

Regression Variable4a (CFO)

Coefficient Estimate

4b (CFI)


4c (CFF)


Intercept -10.25* -12.46* -9.32*

BVE 0.74 0.87 0.99

NI -0.59 -0.44 -0.75

CFO -1.22

CFI -0.35*

CFF 0.36

WaldX2Statistic 0.003

p-value = 0.95

3.69

p-value = 0.05

0.521

p-value = 0.47

*Significant at the 5 percent level.


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Table 5 (continued)


Panel B: R2Results of Regressions of Equation (3).

CFO CFI CFF

Hypothesis Test NI >R

CFO

CFO >R

NI

NI >R

CFI

CFI >R

NI

NI >R

CFF

CFF >R

NI

Prediction NO YES NO YES NO YES

R2of Equation (3) with

different variables

representing UNA

NI: R2 = 0.12

CFO: R2 = 0.15

NI: R2 = 0.12

CFI: R2 = 0.33

NI: R2 = 0.12

CFF: R2 = 0.20

MVE= the market value of equity for firm iat time t.

BVE= the book value of equity for firm iat time t.

UNA= the unrealized net assets of firm iat time t(proxies used are NI, CFO, CFI, & CFF).






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Table 6

Results of Relative Value Relevance of Earnings and Cash Flows - GROWTH

MVEit= 0+ 1BVEit + 2NIit+ 3CFOit+ _ 1it (4a)




Equation



4b (CFI)


4c (CFF)


Intercept 26.78* 24.59* 26.56*

BVE 1.29* 1.40* 1.52*

NI -0.51 0.43 0.27

CFO 1.80*

CFI -0.49*

CFF 0.28


p-value = 0.05

0.90

p-value = 0.34

0.28

p-value = 0.60

*Significant at the 5 percent level.


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Table 6 (continued)



CFO CFI CFF


CFO

CFO >R

NI

NI >R

CFI

CFI >R

NI

NI >R

CFF

CFF >R

NI



different variables

representing UNA

NI: R2 = 0.77

CFO: R2 = 0.80

NI: R2 = 0.77

CFI: R2 = 0.78

NI: R2 = 0.77

CFF: R2 = 0.77









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Table 7

Results of Relative Value Relevance of Earnings and Cash Flows GROWTH/MATURE




Equation



4b (CFI)


4c (CFF)


Intercept 2.34 7.54 -8.15

BVE 0.81* 0.63* 0.66*

NI 7.60* 6.57* 6.91*

CFO -0.96**

CFI -0.20

CFF 0.72**


p-value = 0.01

8.44

p-value = 0.01

9.17

p-value = 0.01

*Significant at the 5 percent level.**Significant at the 10 percent level.


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Table 7 (continued)



CFO CFI CFF


CFO

CFO >R

NI

NI >R

CFI

CFI >R

NI

NI >R

CFF

CFF >R

NI

Prediction YES NO YES NO YES NO


different variables

representing UNA

NI: R2 = 0.80

CFO: R2 = 0.75

NI: R2 = 0.80

CFI: R2 = 0.75

NI: R2 = 0.80

CFF: R2 = 0.74









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Table 8

Results of Relative Value Relevance of Earnings and Cash Flows - MATURE




Equation



4b (CFI)


4c (CFF)


Intercept 13.30 -1.83 -16.90

BVE 0.22 0.33* 0.50*

NI 9.34* 9.92* 10.69*

CFO 1.45*

CFI -0.97*

CFF 0.83**


p-value = 0.01

11.77

p-value = 0.01

19.62

p-value = 0.01



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Table 8 (continued)



CFO CFI CFF


CFO

CFO >R

NI

NI >R

CFI

CFI >R

NI

NI >R

CFF

CFF >R

NI



different variables

representing UNA

NI: R2 = 0.87

CFO: R2 = 0.82

NI: R2 = 0.87

CFI: R2 = 0.81

NI: R2 = 0.87

CFF: R2 = 0.79



UNA= the unrealized net assets of firm iat time t(proxies used are NI, CFO, CFI, & CFF).NI = earnings before extraordinary items for firm iat time t.





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Table 9

Results of Relative Value Relevance of Earnings and Cash Flows MATURE/DECLINE




Equation



4b (CFI)


4c (CFF)


Intercept 71.41* 74.16* 73.48*

BVE 1.05* 1.28* 1.47*

NI 0.75* -0.25 -0.31

CFO 2.50*

CFI -1.07*

CFF 0.09


p-value = 0.01

1.95

p-value = 0.16

0.11

p-value = 0.74



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Table 9 (continued)



CFO CFI CFF


CFO

CFO >R

NI

NI >R

CFI

CFI >R

NI

NI >R

CFF

CFF >R

NI



different variables

representing UNA

NI: R2 = 0.76

CFO: R2 = 0.80

NI: R2 = 0.76

CFI: R2 = 0.78

NI: R2 = 0.76

CFF: R2 = 0.76









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Table 10

Results of Relative Value Relevance of Earnings and Cash Flows - DECLINE




Equation



4b (CFI)


4c (CFF)


Intercept 30.07* 37.39* 38.35*

BVE 1.16* 1.31* 1.35*

NI 0.59 1.44** 1.64*

CFO 2.91*

CFI -0.67*

CFF 0.31


p-value = 0.02

0.19

p-value = 0.66

0.63

p-value = 0.43



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Table 10 (continued)



CFO CFI CFF


CFO

CFO >R

NI

NI >R

CFI

CFI >R

NI

NI >R

CFF

CFF >R

NI



different variables

representing UNA

NI: R2 = 0.39

CFO: R2 = 0.48

NI: R2 = 0.39

CFI: R2 = 0.38

NI: R2 = 0.39

CFF: R2 = 0.37



UNA= the unrealized net assets of firm iat time t(proxies used are NI, CFO, CFI, & CFF).NI = earnings before extraordinary items for firm iat time t.





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APPENDIX A

Relative Information Content Tests in Each Life-cycle Stage

1. NI =RCFO

Run regressions with Whites adjustment:

MVEit= 0+ 1BVEit + 2NIit+ 3CFOit+ _ 1it (4a)

a. Information content of NI:

Define Xas a (n x 3) matrix with a column of 1s to the left of columns BVE and NI.

Define Yas a (n x 2) matrix with columns BVE andCFO.

Define Mas a (2 x 2) matrix = YY - YX(XX)-1XY,with elements mij.

Set N = m11*d3^2 +m22*d4^2 + 2* m12*d3* d4

b. Information content of CFO:

Define Xas a (n x 3) matrix with a column of 1s to the left of columns for BVE and CFO.

Define Yas a (n x 2) matrix with columns BVE and NI.


Set CFO= m11*d1^2 + m22*d2^2 + 2*m12*d1*d2

c. Use Wald Test to test the following restrictions: N =R CFO.


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APPENDIX A (continued)

2. NI =RCFI





Define Yas a (n x 2) matrix with columns BVE andCFI.


Set N = m11*l3^2 + m22*l4^2 + 2* m12*l3*l4

b. Information content of CFI:

Define Xas a (n x 3) matrix with a column of 1s to the left of columns for BVE andCFI.



Set CFI= m11*l1^2 + m22*l2^2 + 2*m12*l1*l2

c. Use Wald Test to test the following restrictions: N =RCFI.


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48

APPENDIX A (continued)

3. NI =RCFF





Define Yas a (n x 2) matrix with columns BVE andCFF.


Set N = m11*n3^2 +m22*n4^2 + 2* m12*n3* n4

b. Information content of CFF:

Define Xas a (n x 3) matrix with a column of 1s to the left of columns for BVE and CFF.



Set CFF = m11*n1^2 + m22*n2^2 + 2*m12*n1*n2

c. Use Wald Test to test the following restrictions: N =R CFF.


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1Other examples in the business press include: Cash is king, Small Business Reports1991, pp.48-56; Cash is king for corporate Japan,Business Week1995, p. 37; Where cash flow is

king, The Economist1995, p. 80.

2Incremental value-relevance is concerned with the overlap of the circles. For example, if theinformation from earnings is in circle A, and the information from one of the cash flow measures

is in circle B, circles A and B can overlap to some extent and both may be incremental to the

other unless the circles are coincidental. But, tests of incremental informativeness or value-

relevance do not test for which circle is larger the other. For a more extensive discussion on

relative vs. incremental information content see Biddle, Seow, and Siegel (1995).3Despite the fact that the great majority of firms on Compustat andCRSPare in later life-cycle

stages, a sample of 192 firm-years is obtained for the start-up group. Mikkelson and Shah

(1993) in a study of IPO firms, found a substantial number of firms (52) during the 1980 - 83

time period, which had gone public, had data available on Compustat, and had no more than one

year of sales history. They provided me with a listing of these firms. I have also been able touse an IPO database provided by Jay Ritter to get some of the stock return data for these firms.

Data from these sources are supplemented with data obtained from Compustat, CRSP,Moodys

Industrialmanual, and annual reports to complete the data requirements for firms, which meet

the criteria for start-ups. This group consists of over a hundred firms that have data on

Compustat or in annual reports.

Kel 1 NoRestriction

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