Reporting of Investment Expenditure: Should It Be Aggregated with Operating Cash Flows?

Abstract

ABSTRACT Corporate managers are often better informed than outside investors about the uncertain future benefits of investments. However, information about investment prospects is not verifiable and therefore not amenable to direct disclosure, but instead inferred by investors from other accounting disclosures. Given this situation, we study the normative question of how the market’s perceptions of uncertainty and its beliefs about the expected level of future benefits of investment should factor into mandatory financial reports of investment expenditures. We establish a threshold of uncertainty in future benefits beyond which it is better to aggregate investment expenditures with cash flow from ongoing operations, rather than measuring and reporting the two separately. We obtain the surprising result that the higher the expectation of future benefits, the lower this uncertainty threshold should be. JEL Classifications: M40; M41; M48.

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