The Effect of Accrual Quality on the Relationship between Free Cash Flow and Financial Performance in Saudi-Listed Firms: An Empirical Study

Document Type : Original Article

Authors

1 Accounting Department Faculty of Commerce Cairo University Cairo Egypt

2 Accounting Department, Faculty of Commerce, Cairo University

3 faculty of commerce, Cairo university

Abstract

The main objective of this study is to measure the effect of accrual quality on the relationship between free cash flow (FCF) and financial performance in Saudi-listed firms. To achieve this objective, we examined a sample of firms listed on the Saudi Exchange during the period from 2008 to 2019, the final sample was 1104 firm-years observations. The results confirm a significant positive relation between FCF and the accounting performance proxies, however, the results confirm an insignificant relation between FCF and the market performance indicators, accordingly the first hypothesis (H1) was partially accepted. The results also confirm a significant negative effect of abnormal accruals on the relation between the FCF and financial performance, so the second hypothesis is fully accepted. This result reflects an increase in the agency’s cost of FCF according to an increase in abnormal accruals- a decrease in accrual quality- in Saudi-listed firms. Finally, additional tests confirm that dividend payout can mitigate a little of the negative effect of abnormal accruals on the relationship between FCF and financial performance. However, depending on dividends payout can not remove the whole negative implications of FCF on the financial performance which coincides with lower accrual quality. Therefore, our final results confirm that the positive effect of accrual quality on financial performance depends on the accrual quality. The results of this study are important for researchers, firms, investors, regulators, auditors, and other stakeholders, regarding the potential implications of FCF on financial performance from the perspective of accrual quality.

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