We find that differences in cash classification choices affect results when the cash flow prediction model is based on sales () but not when the cash flow prediction model is based on cash flows (Barth et al. 2001; Givoly et al. 2009). One implication is that the latter type of model may be more useful in the international context in which flexibility in cash-flow classification exists.
Our study contributes to literature on managerial discretion in the use of non-earnings measures, especially in an international context. Although managerial discretion in cash-flow classification could help financial statement users, our evidence suggests that classification choices are associated with incentives to report higher OCF. We also find that the likelihood of making an OCF-increasing change in classification is positively associated with equity issuance but negatively associated with analysts‘ coverage, consistent with analysts serving some deterrent role. Similarly, being cross-listed in the U.S. decreases the likelihood of making a cash-flow classification change.
Our study also contributes to the debate over costs and benefits of comparability and uniformity (De Franco et al. 2011). Flexibility in cash flow reporting may result in lower comparability and uniformity and thus may create significant costs for users because of the use of cash flows in valuation and contracting. Footnote 7 We provide evidence that the market pricing of the persistence of accruals and cash flows differs, depending on the cash-flow classification choices made. While flexibility in cash-flow classification could lead to more informative OCF, our findings indicate that such flexibility impacts the comparability of reported OCF. Footnote 8
Our study should matter to various audiences. Cash-flow classification choices available under IFRS, but not under U.S. GAAP, potentially limit the generalizability of U.S. evidence relying on reported OCF. Footnote 9 Researchers comparing OCF and other performance measures should be interested in the effects of classification on their estimates (e.g., Bernard and Stober 1989; Sloan 1996; Ashb; Barton et al. 2010).
Motivation and research design
With an increasing number of countries permitting or requiring IFRS (De George et al. 2016), our findings should inform regulators, including the U.S. SEC, which has considered potential adoption of IFRS (SEC 2011). As IFRS allows more flexibility than U.S. GAAP, U.S. regulators should note the variation in firms‘ classification choices and the factors associated with those choices. Footnote 10 Standard setters can use an understanding of the factors associated with a firm’s reporting choices when crafting standards that permit alternatives. In addition, financial statement users may benefit from understanding whether and how management’s cash flow classification choices relate to reporting incentives and firm characteristics (Carslaw and Mills 1991).
The paper is organized as follows. Section 2 discusses the motivation and research design. Section 3 describes our sample selection and presents a comprehensive description of cash flow classification of interest paid, interest received, and dividends received. Section 4 reports results of the determinants of firms‘ cash flow classification choices, while Section 5 includes the analysis of specific consequences of flexibility in classification choice. Section 6 concludes.
Determinants of OCF classification choices
We follow Lee (2012) and explore incentives and reporting environment factors related to reporting higher OCF. Footnote 11 Incentives for reporting higher OCF relate broadly to capital access and contracting. Additionally, reporting environment factors affecting classification choice include industry and market aspects (analysts‘ forecasts and cross-listing).
Because OCF is an important measure in assessing credit and default risk (Beaver 1966; Ohlson 1980; DeFond and Hung 2003), we expect that firms closer to financial distress will be motivated to report higher OCF. We create a 
proxy for financial distress based on Altman’s Z-score (Altman and Hotchkiss 2006). Footnote 12 Arguably, firms accessing equity markets more frequently have a stronger incentive to inflate OCF to increase their valuation and thus the amount of capital they can raise. Therefore we expect that these firms will be more likely to classify so as to enhance their reported OCF. Our proxy for capital market incentives is equity issuances. We expect that, the more firms opt to access the equity markets, the stronger their incentives to report higher OCF. Thus we expect a positive relation between equity issues and OCF-increasing classification choices.