Masoom

CAPITAL UNIVERSITY OF SCIENCE AND
TECHNOLOGY, ISLAMABAD
The Impact of Earning Volatility

and Cash Flow Volatility on Firm
Value: Evidence from Pakistan
by
Muhammad Shahid
A thesis submitted in partial fulfillment for the
degree of Master of Science
in the
Faculty of Management & Social Sciences
Department of Management Sciences
2018
i
Copyright c 2018 by Muhammad Shahid
All rights are reserved. No part of the material confined by this copyright observe
may be utilized or replicated in any form or by any electronic or mechanical means
including recording, photocopy, or by any information retrieval and storage system
without the authorization from the author.
ii
This work is dedicated to my beloved parents who have encouraged me to achieve

this milestone and to my respected supervisor Dr. Ahmad Fraz, who has been a
constant source of inspiration.
CAPITAL UNIVERSITY OF SCIENCE & TECHNOLOGY
ISLAMABAD
CERTIFICATE OF APPROVAL
The Impact of Earning Volatility and Cash Flow Volatility

on Firm Value: Evidence from Pakistan.
by
Muhammad Shahid
MMS-163027
THESIS EXAMINING COMMITTEE
S. No. Examiner Name Organization

(a) External Examiner Dr. Attiya Yasmin Javid PIDE, Islamabad
(b) Internal Examiner Dr. Arshad Hassan CUST, Islamabad
(c) Supervisor Dr. Ahmad Fraz CUST, Islamabad
Supervisor Name
Dr. Ahmad Fraz
October, 2018
Dr. Sajid Bashir Dr. Arshad Hassan

Head Dean
Dept. of Management Sciences Faculty of Management & Social Sciences
October, 2018 October, 2018
iv
Author’s Declaration
I, Muhammad Shahid hereby state that my MS thesis titled “The Impact of
Earning Volatility and Cash Flow Volatility on Firm Value: Evidence
from Pakistan.” is my own work and has not been submitted previously by me for
taking any degree from Capital University of Science and Technology, Islamabad
or anywhere else in the country/abroad.
At any time if my statement is found to be incorrect even after my graduation,

the University has the right to withdraw my MS Degree.
(Muhammad Shahid )
Registration No: MMS-163027

v
Plagiarism Undertaking
I solemnly declare that research work presented in this thesis titled “The Impact
of Earning Volatility and Cash Flow Volatility on Firm Value: Evi-
dence from Pakistan” is solely my research work with no sign cant contribution
from any other person. Small contribution/help wherever taken has been dully
acknowledged and that complete thesis has been written by me.
I understand the zero tolerance policy of the HEC and Capital University of Science
and Technology towards plagiarism. Therefore, I as an author of the above titled
thesis declare that no portion of my thesis has been plagiarized and any material
used as reference is properly referred/cited.
I undertake that if I am found guilty of any formal plagiarism in the above titled
thesis even after award of MS Degree, the University reserves the right to with-
draw/revoke my MS degree and that HEC and the University have the right to
publish my name on the HEC/University website on which names of students are
placed who submitted plagiarized work.
(Muhammad Shahid)
Registration No: MMS-163027

vi
Acknowledgements
First of all, thanks to the most powerful and most beneficial Allah Almighty who
inculcated skills, knowledge and endless effort in me to reach here and accomplish
my research work. He is the one who indulged and raised my interest in research
work. Likewise, my parents, siblings and friends proved to be very supportive
during every task that I had to do for completing my research work. I am very
thankful to my most favorite teacher and supervisor of my thesis Dr. Ahmed
Fraz who guided me very well to complete my research thesis and helped me out
whenever I was stuck in some difficulty and for being with me to support me and
boost my morale to complete my work well.
vii
Abstract
This study aims to investigate the impact of earning volatility and cash flow volatil-
ity on firm value. The study has employed the data of 60 non-financial firms listed
at Pakistan stock exchange for the period of 2003 to 2017. Earning volatility and
cash flow volatility is calculated by creating rolling window of eight quarters. The
systematic risk is measure by using market model on three years monthly data.
The results of the study indicate that increase in earnings volatility and cash flow
volatility have significant negative impact on firm value, Whereas systematic risk
has significant positive impact on firm value. The control variable, return on assets
has positive and significant effect on firm value while leverage and the total assets
have negative and significant impact on firm value. The results are consistent with
risk management theory and suggest managers efforts to produce smooth financial
statements add value to the firm.
Keywords: Tobin Q, Earning Volatility, Cash Flow Volatility, System-

atic Risk.
Contents
Author’s Declaration iv
Plagiarism Undertaking v
Acknowledgements vi
Abstract vii
List of Tables x
1 Introduction 1
1.1 Theoretical Background . . . . . . . . . . . . . . . . . . . . . . . . 4
1.2 Research Gap . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 8
1.3 Problem Statement . . . . . . . . . . . . . . . . . . . . . . . . . . 8
1.4 Research Questions . . . . . . . . . . . . . . . . . . . . . . . . . . . 9
1.5 Objective of the Study . . . . . . . . . . . . . . . . . . . . . . . . . 9
1.6 Significance of the Study . . . . . . . . . . . . . . . . . . . . . . . . 9
1.7 Plan of Study . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 10
2 Literature Review 12
2.1 The Effect of Earnings Volatility on Firm Value . . . . . . . . . . . 12
2.2 The Effect of Cash Flow Volatility and Firm Value . . . . . . . . . 19
2.3 The Effect of Systematic Risk on Firm Value . . . . . . . . . . . . . 25
2.4 The Effect of Un-Systematic Risk on Firm Value . . . . . . . . . . . 27
2.5 The Effect of Size (Total Assets) on Firm Value . . . . . . . . . . . 28
2.6 The Effect of Return on Assets on Firm Value . . . . . . . . . . . . 30
2.7 The Effect of Leverage on Firm Value . . . . . . . . . . . . . . . . . 31
2.8 The Effect of Growth Opportunity on Firm . . . . . . . . . . . . . . 34
2.9 The Effect of Advertising to Sale Ratio on Firm Value . . . . . . . 35
3 Data Description and Methodology 36

3.1 Data Description . . . . . . . . . . . . . . . . . . . . . . . . . . . . 36
3.2 Panel Data Analysis . . . . . . . . . . . . . . . . . . . . . . . . . . 37
3.3 Sources of Data . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 38
3.4 Control Variables . . . . . . . . . . . . . . . . . . . . . . . . . . . . 39
viii
ix
3.5 Measurement of Variables . . . . . . . . . . . . . . . . . . . . . . . 39

3.5.1 Dependent Variable . . . . . . . . . . . . . . . . . . . . . . . 39
3.5.2 Tobin Q . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 39
3.6 Independent Variable . . . . . . . . . . . . . . . . . . . . . . . . . . 40
3.6.1 Estimation of Earnings Volatility and Cash Flow Volatility . 40
3.6.2 Earnings Volatility . . . . . . . . . . . . . . . . . . . . . . . 41
3.6.3 Cash Flow Volatility . . . . . . . . . . . . . . . . . . . . . . 42
3.6.4 Systematic Risk . . . . . . . . . . . . . . . . . . . . . . . . . 42
3.6.5 Beta . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 43
3.6.6 Firm-Specific Risk . . . . . . . . . . . . . . . . . . . . . . . 43
3.6.7 Return on Assets (ROA) . . . . . . . . . . . . . . . . . . . . 43
3.6.8 Capital Expenditures . . . . . . . . . . . . . . . . . . . . . . 44
3.6.9 Long-Term Debt . . . . . . . . . . . . . . . . . . . . . . . . 44
3.6.10 Market Risk . . . . . . . . . . . . . . . . . . . . . . . . . . . 44
3.6.11 Size . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 45
3.7 Methodology . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 45
3.7.1 Earnings Volatility and Firm Value . . . . . . . . . . . . . . 45
3.7.2 Cash Flow Volatility and Firm Value . . . . . . . . . . . . . 45
3.8 Variance Inflation Factor (VIF) Test . . . . . . . . . . . . . . . . . 46
4 Data Analysis and Discussion 47

4.1 Descriptive Statistics . . . . . . . . . . . . . . . . . . . . . . . . . . 47
4.2 Correlation Matrix . . . . . . . . . . . . . . . . . . . . . . . . . . . 50
4.3 Multicollinearity Check of the Independent Variables for the Period
of 2003 to 2017 . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 52
4.4 Diagnostics Test . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 53
4.5 The Results of Fixed Effects Model for Earning Volatility . . . . . . 54
4.6 The Results of Fixed Effects Model for Cash Flow Volatility . . . . 57
5 Conclusion 60
5.1 Policy Recommendation . . . . . . . . . . . . . . . . . . . . . . . . 61
5.2 Directions of the Future Research . . . . . . . . . . . . . . . . . . . 62
Bibliography 62
List of Tables
3.1 No. of Companies and Respective Industries . . . . . . . . . 38
4.1 Descriptive Statistics for the Period of the 2003-2017 . . . . . . . . 48

4.2 Panel-correlation of Earning, Cash flow volatility and other vari-
ables for the period of 2003 to 2017 . . . . . . . . . . . . . . . . . . 51
4.3 Variance Inflation Factors of the Earning volatility, Cash flow volatil-
ity and firm value. . . . . . . . . . . . . . . . . . . . . . . . . . . . 52
4.4 Redundant Fixed Effects Tests. . . . . . . . . . . . . . . . . . . . . 53
4.5 Random Effect Model. . . . . . . . . . . . . . . . . . . . . . . . . . 53
4.6 Fixed Effect Model Show the impact of Earning Volatility on Tobin
Q for the period of 2003- 2017 . . . . . . . . . . . . . . . . . . . . . 55
4.7 Fixed Effect Model Show the impact of Cash Flow Volatility on
Tobin Q for the period of 2003- 2017 . . . . . . . . . . . . . . . . . 58
x
Chapter 1
Introduction
Business risks the likelihood firms have lower than expected profit or experience
a loss instead of taking a Profit. Business risk is influenced by various factors,
including sales volume, per-unit price, input costs, competition, and the overall
economic climate and government regulations. These are all the factors which
can affect the firm value. A company with a higher business risk should choose
a capital structure that has a lower debt ratio to ensure it can meet its financial
obligations at all times. Business risk or firm-specific risk is associated with the
firm value if a firm face lowers business risk, then it has fewer earnings and cash
flow volatility than which firm faces high exposure to business risk. This study
provides some pieces of evidence that earning volatility is highly costly and having
the relationship to less firm value. Manager, analysts and institutional investors
of the firms apparently focus only earning of concern firms rather than cash flow.
Earning volatility plays as a sign of financial stability or instability of firms in ad-
dition to cash flow volatility. There are many justifications why earning volatility
is an important factor for the firm value. In most volatile firms, business analysts
and institutional investors tend to avoid and their recommendation for investors to
also avoid investing these firms. The probability of forecast error increases when
firms have more volatility in their earnings and cash flows. Brennan and Hughes
(1991), Same as (?) discover institutional investor keep away from these compa-
nies, which are facing huge variations in earnings and cash flows. More volatility
in earnings also enhances the chance of negative earnings; in reaction, managers
1
Introduction 2
have engaged in considerable smoothness.

Earning smoothness decreases the firms’ huge probability of default and also bor-
rowing cost. According to the CAPM Systematic risk affect the firm. Further
other empirical evidence shows firm-specific risk also plays a vital role regarding
the value of firms. Firm value is the Tobin q number of shares multiple market
price of the share divided by total assets of the firm. This study finds out if both
types of risk (Systematic and un-systematic) increase then what they have an ef-
fect on Tobin Q which is the proxy of the firm value, There are two major risks
which many companies face the first one is the business risk and the second is
the financial risk. This study regarding business risk in which includes earning
volatility, cash flow volatility and systematic risk and unsystematic risk is also a
subtype of business risk. Earnings volatility refers to how steady, or unsteady,
the earnings of the firms are. An analyst and investor may analysis with annual
earnings figure, may quarterly earnings figures.
The firm, whose earnings fluctuates more than others; it is a great deal for investors
to ignore the risk of volatility which may occur hugely loses in their investment.
This volatility in earnings makes it very hard for senior management to plan fu-
ture. More specifically, when funds must lend for long-term business needs and
investment, It means serious trouble for the firm which is face volatility regarding
collection of funds, even may be resulting in the takeover of assets by moneylen-
ders (creditors) and ultimate, bankruptcy of firm at this stage. The firms did
not continue their operations and it is the only solution to sell out the assets and
pay off the liabilities consequently, directors efforts to maximize earnings, but also
soothe the earnings. Stabilize financial statements means reduce the instabilities
and thereby lower its volatility. Every time earning volatility is not bad. In the
same way, not all steady is the best signal. At the end of the financial year if
the firm created a very minor, Inadequate amount of profit, its incomes would
be extremely stable, but for the purpose of investment such a company would be
unattractive when a firm is finally starting to turn around and grow its earnings,
at this stage the earnings volatility surges since there has a reasonable and unex-
pected variation in earnings of the firms. This type of volatility is called positive
Introduction 3
volatility. Thus, as with each other economically measure, volatility requirement

is to be assessed in the right and precise context.
Literature has argued that corporate risk management theory and investors are
augmenting if a firm keeps reliable cash flows. Froot et al. (rary) assertion that
smoothness in cash flows can enhance the value through decreasing firm depen-
dence on expensive exterior finance. Empirically (Schrand, 1999) explain that
cash flow instability, expensive and it disturbs a firm’s investment strategy by en-
hancing the probability and the expenses of generating outside capital. The unique
frequent subject of this work is that businesses with smoother financial statements
must be additionally highly priced and valued. Earnings volatility happens due
to many reasons. A firm whose earnings tight to the state of the economy of the
country, like as the merchants, and might produce random outcomes when the
economy face recessions and customers aren’t spending on branded items alike
they normally were done. Although no direct evidence exists, but earlier research
discovers that cash flow volatility is costly, the financial reports volatility is linked
to firm value. Such a linkage is significant since, in a tendency for risk man-
agement of matters, smooth financial performance must be priced at a premium
to extra volatility ones. Thakor (2003) recommend that a firm may have stable
earnings so as to minimize the informational benefit of knowledgeable investors
over unaware investors, and therefore defend these investors they might be needed
to trade for liquids. Finally, it is also investigating these companies which have
the smoothness of earnings bear the minor cost of funds even after accounting for
CFV. There are many additional ways where financial uncertainty relates to the
value of the firm. In a manner to the Capital Assets Pricing Model, diversified
risk and firm value adversely connected, meanwhile more discount rates yield a
lower firm value. Further, recent experimental work recommends that systematic
risk not only does affect value, but the two unsystematic risks may be priced. It
might be possible an adverse relation between systematic risk and the value of the
firm, along with a negative and the important relationship between unsystematic
risk and the value of the firm. This research additionally enhances the works by
concentrating on the value effect of two other categories of risk, specifically, cash
Introduction 4
flow volatility and earnings volatility. This study directly tested the hypothesis
that firms stable financial statements are more valued at a premium compared to
these firms which having volatile financial statements. And although this study
does not directly investigate in this work what reasons behind earning volatility
and cash flow volatility, this study has tested the hypothesis that financier gives
more worth to those firms who have with stable cash flows.
The objective of the study by providing further empirical evidence in attempt-
ing the answer of three questions regarding Smooth financial statements; the first
question is that investor gives importance to earning volatility and second ques-
tion cash flow volatility is also the concern of investors or not regarding the firm
value. The third objective to find that the systematic and firm-specific risk affect
the firm value. This study provides strong evidence of earnings volatility or cash
flow volatility, which one affects that the value of the firm most.
1.1 Theoretical Background
Previous work shows that there are many other reasons which are the effect the
firm value. The firm value represents the shareholder’s equity plus long-term lia-
bility divided by short plus long-term assets. Equity holder always preference to
these companies which generate earnings per share and return on stock smooth
which is known as a dividend, it can be influenced by investors, assume as an
investors point of opinion, if earnings per share are on the higher side, then it
might be possible the amount of dividend is too much high on stock other than
low earnings per share. If the dividend is high is high from investor expectations
then, it attracts the investor. Then shareholder can purchase more stock and due
to an increase in market demand of shares, the price of the share increases and it
higher the firm value. If earnings per share of the firm is low, then the dividend is
small as compare to its share price, then the investor who concern with dividend
they sell out their share and supply of the shares increase and it decrease firm
value because the earning per share is not fulfilling the expectation of the investor
its show that the investor has concern with earning per share of an organization
Introduction 5
but companies dont fulfill the expectation when it’s earning per share not smooth
and fluctuate rapidly in the next announcement. A company with strong earnings
per share might see the market price of its stock rise. This higher stock price might
create a positive impression of the company’s products in the minds of customers,
resulting in greater demand, increased sales and ultimately higher earnings. The
inverse might also occur. Poor EPS might depress stock prices. If companies
manage the business in a good way, then the prices of the share are better in the
stock exchange as compare to other company and if companies unable to manage
the business in a good way then company share prices are not good as compared
to other company.
Share prices are directly affecting the value of the firm because the low share price
means the low value of the firm. Earning volatility means the rate of variation of
earnings per share of the firm over a given period of time, higher volatility becomes
the cause of the higher risk of loss or gain. If the earning per share is volatile then
it is very difficult to determine that what the share price of the company is in the
future. If earning per share variation in a positive way then its a good sign. If
the earning per share is volatile then it is very difficult to determine that what
the share price of the company is in the future. If earning per share variation in
a positive way, then its a good sign. If earnings per share are high as compared
to share price its mean is that the financial manager takes wealth maximization
decision. A dividend irrelevance theory is presented by ?. They assume that when
an investor considers the return on investment then he only thinks about company
earnings. The investor has no concern with dividend because investment decision
is dependent on only the investment policy of the company. The inventor has also
determined that a perfect market occurs where market prices do not affect by a
single buyer or seller.
The dividend irrelevance theory has some assumptions.
• Irrelevance theory works when the capital market is perfect and everyone has
complete information about the stock. The transaction cost is zero and no one
can take advantage of other with the same risk.
Introduction 6
• It is assumed that there is no tax. There is no tax difference amid capital

gains and dividend.
• It is supposed that investment strategy of a company fixes and reinvest the

retain earnings and this does not affect the risk of a company so due to this reason
remain constant and also suppose that there is no flotation cost is exist.
According to MM model, it is proved that the value of a firm is not influenced

by the capital structure and net operating income, it is also presented that the
value of the firm only depends on the behavior of the investor. It is dependent
on investor perception if an investor thinks that I have a good opportunity to
invest in this business then it increases the value of a company because it depends
on the behavior of the investor. There are some assumptions about this theory,
investors are free to purchase and sell the commodities and capital markets must
be perfect, nobody can gain unexpected profit with the same risk as compared
to another investor who has the same risk. It is also assumed that investors are
well informed about the risk which is related to securities. It is also assumed in
this model no transaction cost and no taxes are involved in this theory, companies
pay a hundred percent dividend to Shareholders Company never use the strategy
of retained earnings. According to this theory assumption, it is proved that an
investor can in two companies which have different risk and can generate the same
return from both of the organizations.
Net operating income is known as income before taxes and interest and also be-
fore factory overhead expenses. According to the net operating income theory, it
is completely differing to net income theory. In this theory, it is assumed that the
value of a firm is totally negatively linked with the capital structure of a business.
There is some assumption regarding this theory, the first assumption is that the
capital cost of a business is only related to the risk of a business otherwise cost of
capital remain constant. The value of a business is only determined by calculation
of the cost of capital of a business, the cost of outside financing debt is unchanged
and taxes do not exist on corporate income. The Shareholders risk increase when
Introduction 7
business increases borrowing, debt, as we can say that the capital structure of a
business is not affected by the value of an organization. Most companies used net
income approach because these approaches define the linkage between the capital
structure of a company and the value of a business. According to this theory, the
value of a business is and a companys directly affected by the capital structure
of an organization because the capital structure and a value of a company are
connected with each other. Cost of capital means what a company bears at the
expense making a product and until to sell a product.
There is some assumption regarding the net income approach of capital structure,
the first assumption is that observation of an investor is not affected by continu-
ally increase in debt of a company, the second assumption is that the equity cost
of a business has always been higher than the debt cost of a company, and the
third assumption is that there is no involvement of taxes on a company’s corporate
income. It is also assumed that the cost of capital of a company can be decreased
by increasing in debt of a company. The value of a business can be increased
by reducing the capital cost of a business and sustain the earnings of a company.
When a business increases its outside finance then its become a cause of the de-
crease in the capital cost of an organization, and it only occurs when a company
only depends on debt.
The capital structure means a mix combination of a company’s total capital, which
can be in the form of equity, surplus, and reserve and also include the loan from
commercial banks other financial institution different type of securities and deben-
tures, the value of a company only depend on the cost of capital and earning of a
company. As we know that the core objective of a company financial manager to
maximize the wealth of the companys shareholders. The capital structure of an
organization has no impact on net income of a firm but it can affect the residual
earnings of shareholders. This purpose of a firm is only achieved when a firm
designs a good and unique capital structure. It is very difficult to make to make
a good and unique capital structure. A good capital structure is a backbone of a
company’s growth because if capital structure is not good, then it creates a con-
flict between management and shareholder who is known as agency problem and it
Introduction 8
also affects the company growth. A good capital structure is only achieved when
a firm creates a balance between shareholder expectation and capital or finance
requirement of an organization.
1.2 Research Gap
The companies in Pakistan operate in an uncertain and dynamic environment, for

which company not only needs to adapt its management to these changes, but
also be financially able to cope up with these. This requires companies to be able
to identify the target smoothness in the financial statements and then be able to
identify the factors which can impact a firm’s ability to reach these targets. The
earnings volatility, cash flow volatility and both types of risk may affect the Value
of the firm. The changing nature of the financial environment influences the firms
to make financial statements smother, means to have such a structure which is
able to adjust according to the changing requirements. The available literature
shows that there is a vital impact of the volatility (earning and cash flow) upon the
firms value. Keeping in view the voluminous trading securities, based on the high
frequency and high speed in parallels time horizon, this study found a few works
both of earning and cash flow volatility, especially in the context of Pakistan.
1.3 Problem Statement
There is vast volatility in financial statements. To examining the influence of

earnings volatility and cash flow volatility as the determinant factor of the investors
decision making about the investment in the firm’s stock. Earning volatility and
cash flow volatility of the non-financial sector of Pakistan is the central issue to
be addressed. The center of attention in the study is whether earning volatility
or cash flow volatility affect positively or negatively, which may lead to the basic
guidance for allocation/re-allocation of scarce resources.
Introduction 9
1.4 Research Questions
This study has the following research questions:
1. Does earning volatility have an effect on the Firm Value?
2. Is there cash flow volatility have an impact on the firm value?
3. Does systematic risk affect the Firm value?
4. What is the effect of firm-specific risk on Firm Value?
1.5 Objective of the Study
This study has the following objectives:
• To explore the relationship among earning volatility, cash flow volatility and
Firm Value.
• To investigate diversified and un-diversified risk affects the firm value.
1.6 Significance of the Study
It is argued that the study of earning volatility and cash flow volatility is important
because these are affecting the firm value. No previous work in Pakistan has
investigated directly such relationship between the value of the firm and stability of
financial statements. This is very meaningful as well as giving a strong explanation
for the wider risk management actions that firms are involved. The findings of
this investigation are reliable with the actions of many market participants who
seem to give intention on the earnings as a strong sign of financial smoothness
and stability. This study helps out the managers to make efforts to create and
Introduction 10
maintain a stable and smooth financial statement which adds value for the firms.
This study also is helpful for managers make better understand the association
between earning volatility, cash flow volatility and firm values. The findings of
the study serve as a tool to make the best decision on which firm to do invest.
Individual investors also are able to forecast the future value of the firm simply
looking into volatility of earnings and cash flows. Companies in Pakistan operate
in an unpredictable and dynamic environment, for which Company not only needs
to adjust its management to these variations but also financially be able to manage
up with these. Another contribution of this study is that it brings together all
type of variables, which have never been brought together in a research before in
case of Pakistan such as systematic risk and Firm-specific risk variables.
This study allows the firms in Pakistan to have an overall view of all the factors
which can impact their aim to attain target smoothness in financial statements to
add value for the firms. This requires companies to be able to identify the target
smoothness in the financial statements and then be able to identify the factors
which can impact a firm’s ability to reach these targets. The changing nature
of the financial environment influences the firms to make Financial Statements
smother, means to have such a structure which is able to adjust according to the
changing requirements. Once this is done, firms must also be able to identify the
time period) which they require to reach those targets. This study also allows
the firms to be able to deal with all the issues mentioned above. This study is
also helpful for managers to make better understand the association among stock
liquidity and dividend policies. The findings of the study serve as a tool to make
better dividend payout policy to attract the investors. Individual investors also
are able to forecast the future dividend payout by simply looking into liquidity of
the stock.
1.7 Plan of Study
The plan of the study is chapter 1st introduction about earning volatility, cash
flow volatility and firm value, this chapter also contains theoretical background,
Introduction 11
problem statement, research objective research questions and the significance of

the study. The 2nd chapter includes existing literature and their findings. The 3rd
chapter covers the data descriptions, measurement of variables and methodology
of the study. The 4th chapter is of results, their interpretations, and discussions.
Lastly, the 5th part entails of conclusion policy recommendations and future di-
rections.
Chapter 2
Literature Review
2.1 The Effect of Earnings Volatility on Firm

Value
Badrinath et al. (1989) investigated the effect of earnings volatility on the firm
value and finds out that institutional investors usually tend to avoid companies
that are perceived to be risky or firms with high earnings volatility, instead, the
firms with smooth earning streams are usually preferred. The volatility in firms
earning can result in the error surprises and it might end up increasing the firms
estimated cost of capital and the consequent reduction in the firms value. Certain
tests that were performed in previous studies were unable to find the clear negative
association of earnings volatility with the firm value, but it is also evident that
many companies tend to avoid the volatility in their earnings by adjusting their
real activities. The measure of earnings is important as it highlights the perfor-
mance of the firm and the volatile environment of a firm and in case of volatile
earnings, it could result in the negative association with the cash flow that may
lead to the decline in the firms performance.
Minton and Schrand (1999) argued in their study that earning volatility and cash
flow volatility has a negative impact and the results of their studies suggest that
the volatility in earning is negatively associated with the firm value and market
value. There is evidence from the literature to support the hypothesis that earning
12
Literature Review 13
volatility is negatively associated with the firm value as studied by (Faccio and
Lang, 2002). Moreover, firms also can affect the firm value directly by earnings
smoothing that is linked with the earnings volatility.
Iyer and Harper (2017) investigated the reported earnings and their associations
with the discretionary accruals, the results show that firms with high prospects
usually smooth reported earnings to affect the firm value. Study of previous em-
pirical work tells that volatile earning is usually avoided by the analysts and the
firms as the likelihood of forecast errors is increased considerably, argued by the
(Brennan and Hughes, 1991).Badrinath et al. (1989) performed a similar study
and assessed that the companies with large variations in their earnings are usually
avoided by the institutional investors. The chances of negative earnings surprises
are also increased with high earning volatility, which results in the engagement of
managers in extensive earnings smoothing. Basu (1997) argues that there is not
much consensus in the literature that earning volatility provide viable information
or show any association with the market value of the firm due to neutral conven-
tions and accounting applications such as conservatism Dechow and Dichev (2002).
Schipper (1991) earnings volatility discussed along with cash flow and firm value.
Volatile earnings are smoother with positive cash flows. It is well understood in
the market that steady cash flow is the crucial process of volatile earnings. Earn-
ings volatility is related to underinvestment in capital uses. Earnings volatility
has additionally expanded the expenses of getting to capital markets that could
be utilized to cover money shortages. Thus, all the more expensive access, thus,
compounds the underinvestment issue. Steady with speculations that foresee more
educated exchanging when open data is less useful Howatt et al. (2009). From a
previous couple of years, the volatility of the standard stock return has radically
outpaced add up advertising instability. In this way, peculiar return volatility has
drastically expanded. Nonetheless, discoveries educated exchanging is weakened in
settings in which hypothesis recommends that optional smoothing or the volatility
of profit is probably going to be educational. Steady with a productive market,
this outcome is reflected by an expansion in the peculiar instability of first money
streams. Individuals contend that these discoveries are inferable from the more
extraordinary broad rivalry. Different cross-sectional and time-arrangement tests

bolster this thought. One part of collections is to move or modify the acknowl-
edgment of money streams after some time with the goal that the equal numbers
(income) better measure firm execution. In any case, accumulations require sup-
positions and appraisals of future money streams (Howatt et al., 2009).
Bidask spreads, and the likelihood of educated exchanging are higher both when
income is smoother than money streams and furthermore when profit is more
unstable than money streams. Extra tests recommend that chiefs’ arbitrary de-
cisions that prompt smoother or more volatilely earnings than money streams
confuse data, all things considered Cao and Narayanamoorthy (2011).
Shipe (2015) Income instability alludes to how steady, or unsteady, the profit of an
organization is. An expert may work with yearly or quarterly income figures. An
organization whose income changes an impressive arrangement is a risky venture.
Such volatile profit makes it difficult for the administration to prepare. Mainly
when stores must be obtained for long-haul speculations, the anticipated income
to respect obligation commitments may not appear. This can mean substantial
inconvenience, notwithstanding bringing about the seizure of benefits by loan spe-
cialists, and, in extraordinary cases. Like that administrators attempt to boost
profits, as well as to standardize the profit. Normalizing a variable means limiting
changes and subsequently lessening its volatility. Earnings volatility changeability
after some time in a laborer’s income is fascinating for its potential welfare results
and as a work showcase result. Within sight of liquidity limitations, families most
likely will be unable to smooth utilization when looked with unstable income.
Another variable that examiners nearly track is the instability of the stock cost.
Since stocks exchange and are estimated on each business day, significantly more
stock value information gathers than income information. Consequently, exam-
iners do not have to sit tight for quite a long time before they can ascertain the
volatility of a stock’s cost. For the most part, the steady the profits of an en-
terprise, the more steady the cost of its stock. Financial specialists lean toward
stocks with stable costs and a consistent uptrend. This makes monetary arranging
simpler and limits the danger of a sudden, cataclysmic misfortune (Howatt et al.,
2009).
It is considered an important factor of capital structure because it governs the
probability of financial distress. De Bondt and Forbes* (1999) more volatile are
the earnings of the firm, more difficult and uncertain, it becomes to make the inter-
est payments and meet debt obligations, so firms with higher earnings volatility
should use lower debt. Almost all of the researchers who have conducted the
study on this aspect of the capital structure have found a negative relation be-
tween volatility and leverage such as Booth et al. (2001).
Choi and Richardson (2016) according to these studies, there can be two per-
spectives to understand the relationship between earning volatility and leverage,
either the debt financiers require higher return due to volatile earnings, so debt
financing more costly to the firm. The other perspective is that due to uncertain
earnings, the firm not able to manage regular repayments. In both cases, leverage
and volatility are inversely related.
Antoniou et al. (2008) agency Theory predicts a positive relationship among
volatility and leverage; it is because the problem of underinvestment gets resolved
due to increased earnings volatility.
Zhuosi (2006) not all earnings volatility is awful. So also, not all strength is ex-
cellent. If an organization was making a little, unacceptable measure of benefit a
seemingly endless amount of time, its income would be profoundly steady. How-
ever, such an organization would be an ugly speculation prospect. At the point
when an enterprise is at last beginning to turn things around and develop its ben-
efits, the income instability will be incremental because there will be an exciting
and sudden change in profit. Such instability is certain. In this manner, as with
each other money-related measure, instability must be assessed inside the correct
setting.
Profit can be volatile for some reasons. Organizations, whose benefits are fixed
to the condition of the economy, for example, retailers, could create erratic out-
comes when the economy moderates and shoppers are not spending on mark name
things like they typically do. Sustenance organizations could create volatile out-
comes when the cost of wares, for example, grains and deliver, rise and expenses go
up. Polica and mak, (2015) looked to patch up the bookkeeping model insurance
agencies utilized for revealing different kinds of protection contracts. If embraced,
the change was relied upon to prompt volatility starting with one quarter, then
onto the next among insurance agencies and other money-related establishments.
Frank and Goyal (2009) they find that earnings volatility has a noteworthy neg-
ative impact on a company’s capital structure. Our outcome could get from two
primary differences. First, utilize yearly fluctuation of benefit returns as volatility
measure. Conversely, they utilize a contingent earnings volatility measure created
by De Second; utilize a direct relapse to locate the solid components. Conversely,
they consider the way that our relevant variable (obligation proportion) is an ex-
tent variable and the contingent desire is a nonlinear capacity of the independent
factors.
A company’s estimation of money and interest for trade rely upon changes out
the association’s outward and inward conditions. Since the utilization and estima-
tion of money are time fluctuating, the ideal level of money property is likewise
continually evolving. The progressive idea of ideal money property ought to in-
spire firms to modify money towards the ideal level efficiently. The advantages
of altering money towards its ideal level can be significant, including diminished
overinvestment prompting exhausted money holds, constrained money storing,
and smoothing the impacts of the financial cycle by guaranteeing the measure of
money is adequate to withstand tough circumstances. These advantages propose
that: if a firm continually changes money property to pursue the ideal money level
and consequently expands the instability of money possessions, there ought to be
a comparing increment in firm esteem (Das et al., 2013).
De Veirman and Levin (2011) Furthermore, the connection between earnings
volatility and firm value ought not to be homogenous crosswise over firms. More
youthful and smaller firms have constrained access to moderate outer capital, and
in this manner, money is a more significant advantage for them. In the meantime,
smaller firms likewise tend to be less beneficial. Because of the popularity yet
restricted supply of money, altering money to its ideal level is particularly im-
perative for those organizations. Subsequently, the connection between earnings
volatility and firm esteem ought to be considerably more grounded for littler and
more big firms. Locate a more grounded relationship between earnings volatility
and firm an incentive for more youthful firms contrasted with more established
firms. As firm size expands, the size and essentialness of the connection between
money instability and firm esteem diminish monotonically. Innovative firms need
to exploit venture openings rapidly because of the power of rivalry in their en-
terprises and the steady formation of new items and administrations. The fast
changes in the outer condition and venture openings in cutting-edge businesses
infer that the ideal money level is more unstable in innovative firms than in low
tech firms. Cutting-edge firms that effectively alter money to its ideal level should
profit more than low-tech firms whose ideal money level is not as unstable.
Earnings volatility ought to be imperative to firm esteem. Profit instability is not
quite the same as standard volatility since a parallel occasion expands it. Profit
is declared either before the market opens or after the market close and volatility
is ordinarily at its pinnacle just before the declaration. This is because of the
vulnerability of the stock course and the extent of the move after the profit dec-
laration. Since instability is pulverized directly after the declaration, they get a
kick out of the chance to offer a premium for income plays. They have discovered
that end profit play on the open after the declaration brings about the best execu-
tion over the long haul. The significance of earnings volatility for an association’s
esteem has for entirely some time been perceived in the bookkeeping and back
writing. Such volatility can affect either through its connection to the markdown
rate or expected money streams (profit) in valuation models. The most current
examination has concentrated on the connection between the markdown rate or
cost of capital. One built up the result is a definite connection between Earnings
volatility and several measures of the cost of capital (Das, Hong & Kim, 2012).
Beaver and Manegold (1975) give confirm that the difference between the earnings
to value proportion is the bookkeeping variable that is most connected with an
association’s beta coefficient. Minton and Schrand, (1999) locate that verifiable
earnings volatility is firmly connected to the beta coefficient, profit payout propor-
tion and offer value instability. Gebhardt et al. (2001) demonstrate that earnings
volatility - estimated as the standard deviation of profit per share - is firmly con-
nected with the ex-risk cost of capital suggested from the lingering pay display.
Investors, proprietors, and officials like their income smooth and put forth an ad-
mirable attempt to accomplish enduring profit that develops quarter-over-quarter.
In any case, one methodology for dispensing with profit instability that is fre-
quently underutilized is supported bookkeeping. On the off chance that an orga-
nization has a dynamic supporting system and does not matter fence bookkeeping,
the quarterly pick up, and misfortunes of its fences are reflected in income. At
the point when support bookkeeping is utilized, and a substance can demonstrate
that the fence and supported things are associated, changes in the estimation of
the supporting instrument are then not secluded in profit (Jayaraman, 2008).
Utilizing subordinates to deal with an organization’s introduction to various dan-
gers (i.e., financing cost hazard, outside trade chance, product chance, and so on.)
is a typical hazard administration strategy utilized by numerous organizations.
Utilizing support bookkeeping to represent the subordinates can expel from the
profit the effect of changes in an incentive on the subsidiary and help limit in-
come instability. For whatever length of time that the quantifiable relationship be
tweens the supporting instrument and the supported thing exists, an organization
can exploit the advantages accessible with fence bookkeeping. The bookkeeping
standard that a substance takes after decides the subtleties of fence bookkeeping
that must be met and taken after. At the center of any credit, the relationship
is essential that loaning foundations stretch out credit to organizations given the
credit value of the organization. Credit value is surveyed through numerous vari-
ables including an organization’s future income consistency and the probability
that the organization had the capacity to benefit the obligation time frame over-
period for the life of the advance. Much like what was clarified in the official
pay area, income that is affected by occasions that are not identified with typical
tasks, for example, intermittent increases and misfortunes from supporting move-
ment, can reduce the consistency of future profit from the bank’s point of view
and impact their loaning choices (Harash et al., 2014).
H1: There is a significant negative relation between earning volatility and firm
value.
2.2 The Effect of Cash Flow Volatility and Firm

Value
A big sample of non-financial firms has been studied to find out the evidence of
cash flow volatility linked with the firm value. Cash flow volatility is negatively
associated with the firm value or Tobins Q and the association is found out to
be significant when the market to book ratio is utilized as a measurement. 30%
to 37% reduction in firm value was observed when the cash flow volatility is as-
sociated with an increase in one standard deviation in the cash flow volatility,
(Thomas and Zhang, 2002). A recent study suggests that if the cash flow volatil-
ity is more costly then the effect on firm value had negative as documented by
(Schrand & Minton, 1999). They studied the evidence from the results of them
and find out that hedging may also have a positive effect on firm value, but the
study also complements the cost of cash flow volatility that has a negative impact
on the firm value for being much costly (Leuz et al., 2003).
Minton and Schrand (1999) that higher cash flow volatility is related to lower com-
mon associate degrees of investment in capital expenses, R&D, and advertising.
This affiliation shows that ”firms do no longer use external capital markets to ab-
solutely cash flow shortfalls but instead permanently forgo investment. Cash flow
volatility is also associated with better prices of having access to outside capital.
Moreover, those higher expenses, as measured with the aid of a few proxies, imply
an extra sensitivity of investment to cash flow volatility. Thus, cash flow volatility
not most effective increased the probability that a ”firm will want to get an entry
into the capital markets, it also increases the cost of external financing.
Cormier et al. (2013) also find out that after accounting for the cash flow volatility,
lower cost of capital is observed with greater earnings smoothing. Thomas and
Bernard, (1990) argue that there is an association between the cash flow volatility
and stock returns that reflect the nave fixation on the return earnings by investors.
A recent study based on the evidence from the study of corporate executives indi-
cates that financial markets usually prefer smooth earnings and cash flows (Harvey,
Gopal, & Graham, 2005).
The Study results suggest that almost 97% of the responses were in favor of
smoother cash flow and smooth earnings. These results clearly support the hy-
pothesis that cash flow volatility is avoided by the firms because it is inversely
associated with the value of firm and Tobins Q. Moreover, studies also suggest
that hindering the volatility and volatility reduction models such as hedging or
reinsurance should also be determined individually for the different type of firms
according to their working environment and growth opportunities. For example,
when the market risk premium is high due to the cash flow volatility, firms should
manage the risks and volatility with less intently as compared to the periods when
the market risk premium is high. Other studies also suggest that cash flows that
show volatility do not usually reveal private stats and information, unlike the earn-
ing volatility that reveals private information with regards to the firm (Melumad
& Kirschenheiter 2002).
Basu, (1997) the whole scenario put by the literature study to find any significant
relationship between firm value and cash flow volatility indicate that there is a
significant impact of cash flow volatility on Tobins Q and firm value. Smooth cash
flow maintained by a firm is considered to be better as per the CRM (Corporate
Risk Management) Theory. Smooth cash flow, according to (Scharfstien, Stein, &
Froot 1993), can add value by minimizing the reliance of a firm on external finance
which is more costly.
(Badrinath, &.G, 1989) also argued that firms investment policy can be affected
by cash flow volatility as it is costly and it increases the likelihood of raising ex-
ternal capitals along with the costs. Study of previous empirical work tells that
volatile earning is usually avoided by the analysts and the firms as the likelihood
of forecast errors is increased considerably, and a similar study assessed that the
companies with large variations in their earning are usually avoided by the institu-
tional investors. The chances of negative earnings surprises are also increased with
high earning volatility, which results in the engagement of managers in extensive
earnings smoothing.
Olsen, Francis and Lafond, (2004) also find out that after accounting for the cash
flow volatility, lower cost of capital is observed with greater earnings smoothing.
In addition to the association of earnings volatility to the cash flow volatility, it
might also be associated with the firm value. Financial uncertainty relates to the
firm value in a number of ways and as per the CAPM, systematic risk or idiosyn-
cratic risk also affects the firm value. There are certain independent variables
that can be associated with the firm value and firm performance where the firm
value is the dependent variable. The measurement of these variables is important
since it signifies and highlights the financial stability of a firm. Moreover, Firms
risk management policies and managerial decisions also directly affect the actual
financial stability of the firms financial statement. Other latest aspect of works
has absorbed on relating hedging actions to firm worth and on investigating the
evidence behindhand hedging, specifically, the CFV is expensive for the compa-
nies.
Allayannis and Weston (2001) discovers that the usage of currency derivatives is an
alternative for hedging progresses worth significantly. They find out evidence that
cash CFV is highly expensive and that it’s long lasting disturbs investment. They
also find out a solid adverse linking among CFV and regular stages of investment
in asset expenditures, Research & development and advertisement expenditures,
and positive connotation among CFV and expenses of retrieving outside capital.
These results recommend that CFV raises equally the chance of the expense of
retrieving outside capital marketplaces.
Myers and Majluf (1984) demonstration that external capital more costly than in-
ternal capital. Consequently, firms that require greater outside capital relative to
internal capital may have lower funding, all else the same, assuming firms comply
with the simple net present value (NPV) decision rule for capital budgeting. That
lower analyst following implies greater statistics asymmetry and a better cost of
gaining access to fairness capital firms with better cash flow volatility has better
equity capital costs. Together, the two effects of cash flow volatility mean that
discounts on cash flow volatility through chance management, sports can lessen a
firm’s anticipated under investment’ fees.

Froot et al. (1993) two sorts of capital shape alternate are examined: provider
change offers, and recapitalization. The effects indicate that both stock costs and
firm values are positively related to adjustments in debt degree and leverage; senior
protection prices are negatively related to these capital shape alternate variables.
This evidence is regular with the fashions of most effective capital structure and
with the speculation that debt degree changes launch information approximately
modifications in company value.
This researchers is paid to current works by directly tested hypothesis firms with
smother Financials are prized at superior comparative towards firms, with an un-
stable financial although monitoring for additional elements of firm value, such as
the size of a firm, the leverage (Debt to Equity ratio), profitability, and growth
(capital expenditure /sales), along with other sorts of risk, such as un-diversifiable
risk and diversified risk. More specifically, if the CFV is highly expensive as rec-
ognized by (Myers, 1977) then it must be negatively distress value of the firms.
This hypothesis covers the findings (Olawale et al., 2017) by an explanation of
this question of why the positive effect of hedging on firm value. This is a vital
consequence as it recognizes the spread tool concluded Firm value can be influ-
enced by risk management. i.e. by making the smooth sequence of firms financial
statements. Additionally, this consequence also proof taking place the expenses
of the CFV, it has documented the negative effect of CFV on the firm value.
They also examine the hypothesis of EV negatively disturbs firm value. FRM also
affects CFV, and in short and long turn, earnings volatility. Yet, the firm can
also affect EV traditionally by placing in earnings smooth via accrual estimates.
This literature has reported a large number of explanations why the rest of these
firms may want to show smoother earnings. For example, small EV may increase
professionals’ following and increase value.
Lang et al. (2002) charm a higher number of formal investors (Badrinath et al.
1989), or/and decrease the outward borrowing costs Trueman and Titman (1988),
Several speculative models have been established quarrelling that revenue smooth
spreads to administrators wish to sign their private information about upcoming
incomes to investors (Melamud, 2002) Specified these opinions, if revenue smoother

through accruals are prized by investors before they suppose EV to be adversely
associated to firms value after accounting for CFV. The historical observed study
in risk management has responded to a sequence of main questions. For instance,
Smith (1993), have studied currency, interest rates, and commodity hedging events
by firms crossways sectors or private a precise manufacturing sector and the level
to which these events are consistent with existing hedging theories.
Smith and Stulz (1985) Associated work has inspected additional prevarication
activities which as the usage and connection of business financial results and accu-
mulation management Barton (2001). The portfolio smooth relative between CFV
and one month to five months or up to six-year earnings at the fixed level with
numerous control of return explanatory variables that contain the FamaFrench
4 factors of size, market, book to market and price momentum, earnings mo-
mentum (Chang et al., 1996), illiquidity and earnings yield. Fama and MacBeth
(1973) regression measured for the FamaFrench 4 factors, volatility experiences a
monthly profit 20% or less as a result of volatility. The rating reason of CFV is
due to un-diversified volatility and diversified volatility after that total cash flow
is disintegrated interested in un-diversified or diversified cash flow proportional to
the sectors mean, they find out that both systematic volatility and unsystematic
volatility are valued similarly with the all over volatility. In detail, these are three
instabilities change with each other. If anticipated CF is disparate to the equity
holders risk, q must be adversely associated with diversified risk for the reason
that cash flows are reduced at a greater rate for companies with bigger and higher
diversified risk and they would suppose un-systematic risk to have no relative with
organizations value.
Our suggestion is consequently unpredictable with the opinion that probable cash
flows are un-connected to risk and displays as a substitute that predictable CF
must rise with systematic risk if the capital marketplace discounts cash CF using
the CAPM model. Additional, our indication demonstrations that anticipated CF
increase with diversified risk to a level greater than would be compulsory to bal-
ance the effect of the rise in market risk on the discount rate to retain the existing
value of CF constant as market risk increases Bhagat et al. (2015).

Figlewski (1997) modern finance theory suggestions numerous explanations why
anticipated CF might be linked to the risk of cash CFV. The value of the firms
is frequently decomposed into the worth of resources in place and the worth of
GO. There is a significant work that highlights the option belongings of growth
forecasts. Cash flow is the real growth opportunities from assets. Companies
which are face large and greater cash flow volatility would have extra appreciated
growth chances all different kept endlessly. The actual choices, growth opportuni-
ties consequently recommends that a companys. Tobin Q increased with the firm’
systematic and unsystematic risk.
Bali and Cakici (2008) companies with vital total volatility have a tendency to
present both enormous un-systematic volatility and vast un-diversified volatility.
The meaninglessness of the outcomes to the cash-flow breakdown is possible be-
cause cash-flow is not straight operated, and consequently corporations not in-
spired to peg down their own cash-flows to the industry (sector) mean accordingly
to, their experiences to industry (Sector) cash flows. The final piece of suggestion
is that the cash-flow instability outcome is the changed from the un-systematic
return volatility result affected the group and firm levels and that neither decision
drives the other, while they are extremely connected at the portfolio level, tall
cash-flow volatility portfolios show very tall un-systematic volatility.
Though, in categories of portfolios on CFV organized for un-systematic return
volatility, the CFV conclusion clusters in average to medium return volatility firms.
The return of volatility effect groups in average to medium CFV firms. The cash-
flow volatility consequence is diverse from the return volatility result in firms of
the highest 29% to 32% of cash-flow volatility, only top 29% to 32 of idiosyncratic
or un-systematic return volatility. Additionally, regulatory for CFV, FamaFrench
four-factor spread among the smallest unstable cash-flow quintile and the greatest
volatile cash flow quintile is .69% a month at 1% significance level. This spread
scope is alike to un-conditional spread after there is no regulator is enforced. The
CFV effect is diverse from the return volatility that affect at the firm level Fama
and MacBeth (1973) their consequences an extensive variety of strength checks.
Ang et al. (2006) conclusions that cash flow volatility, emphasizing the sensitive-
ness consequences to the approximation gaps of volatility, budget systems for the
portfolio returns, breakpoints for portfolio categorization, to extend and volatility
controls. Haugen et al. (1996) reported that the income yield (earnings to price
ratio) is positively associated with future returns.
H2 : Cash flow Volatility significant negative associated with firm value.
2.3 The Effect of Systematic Risk on Firm Value
Higher discount rates usually yield a lower value so, according to the CAPM,
systematic error is negatively associated with the firm value or it should have a
negative effect when it is related to the firm value or Tobin Q. Also, the further em-
pirical study that was done recently suggests that the systematic risk could have
a major consequence on the firm value and not just this, idiosyncratic risk can
also be priced and have an impact on the firm value as argued by (Shin and Stulz
(2000)) . Because omitted control variables to calculated risk management and
firm risk, there is a important change in measuring the risk factor for hedging and
non-hedging firms as neglecting those variables may hinder important differences
among firms behavior and the environment in which hedging and non-hedging
firms operate. Econometric procedures and simultaneous equations are often used
by some authors to analyze this problem Graham and Rogers (2002)
Firms also use derivatives to reduce systematic risk as strongly suggested by the
univariate results. According to the Capital Asset Pricing Model (CAPM), the
implications of the corporate hedging decisions and risk assessment has been given
a detailed study and treatment and it suggests that the essential and important
factor that matters in the risk management is the systematic risk (Logue and Old-
field, 1977): and (Lessard, 1979)). The authors evidently argued that the value
of a forward contract would be zero due to imperfections like default risks and
transaction costs, that would have an impact on the firm value and Tobins Q. The
economic significance, when there are economic conditions like high market risk
premium and the risk-free rate, are pronounced at those times and the significant
economic relationship between the systematic risk and the market value of the
firm can be articulated.
Firms in the industry might possess small or large growth opportunities depend-
ing on the environment they are working in where investors tend to look for a
stock and firm with a particular risk profile to compensate the other background
risks that can affect the stock price ((Orlitzky et al., 2003). The process of risk
management and its association with the market value of the firm is basically the
understanding of the different possibilities (upside as well as the downside) and
risks that firms usually face. The upside or downside potential due to systematic
risks can significantly affect the firms value as the portfolio.
Kiselakova et al. (2015) investigate risk and their impact on firm performance.
They used secondary data for the purpose of the study examines the different
types of risk on firm performance. The selected countries of Europe (Germany,
Austria, France, Italy, United Kingdom and Poland) are incorporated. The selec-
tion based on the devolved and emerging countries They also examine internal risk
which arises from the internally of the organization.to explore the effect there are
many variables used i.e. systematic risk unsystematic risk inflation country risk
financial structure (leverage). Financial result no one can predict either economic
or enterprises. Results of the calculations established that higher impact of un-
systematic risk on a value of the risk than systematic risks. For confirmation, this
result is building Enterprise Risk Model (ERM), which contained certain financial
indicators, systematic and unsystematic risk and forecast models.
Buckley and Ghauri (2004) show that international firms decrease their market risk
because of the expansion advantage of getting cash flows in exceptional nations.
It is posited in this text that international corporations may additionally boom
their market danger appreciations to an increase inside the preferred deviation of
CV from the international market, which offsets the decrease correlation associ-
ated with diversification. Evidence of a substantial high-quality dating among the
extent of systematic risk in a firm and the degree of that company’s international
market is provided. This evaluation is regular with located practices utilization of
better markdown rates in assessing global plans.
H3 : Systematic Risk is significantly impact to the firm value.
2.4 The Effect of Un-Systematic Risk on Firm

Value
Just like the systematic risk, studies suggest that un-systematic risk or idiosyn-
cratic risk is also having an adverse consequence on the firm value ((Shin and Stulz,
2000). It is evident from the recent studies and literature that un-systematic risk
also matters and it can be significantly associated with the firm value and firm
performance (Santa Clara and Goyal, 2003: and Xu and Malkiel, 2002). On the
other hand, ((Logue and Oldfield, 1977) argue that as per the CAPM, the un-
systematic risk can be diversified away and the association with the firm value
could be hindered in the process of creating portfolios of the investors.
Barth et al. (2001) argue that un-systematic risks increase when there are any
mergers and the market value of the firm is significantly associated with the un-
systematic risks. The negative impact of the un-systematic or idiosyncratic risk
is evident from the literature studies that parallel existing asset pricing works,
which finds a signal that systematic risk also matters and it affects the Tonins
Q (McShane et al. (2011)). Goyal and Santa-Clara (2003) also find out that un-
systematic risk matters and associated with the firm value.
Reinsurance or hedging does not change the value of the stock or the firm value
due to the reduction in total risk, systematic and un-systematic as suggested by
the risk management textbooks. As per this suggestion and recommendation,
there should not be a significant relationship between risk management program
and the market value of the firm but this is only a hypothesis based on certain
evidence from the study of several non-hedging firms. On the other hand, the em-
pirical study of the literature suggests that un-systematic risk is associated with
the stock value of the firm (Verrecchia, 1989). That being stated, other experimen-
tal outcomes likewise reveal conditions where a decrease in the total risk prompts
either a decrease or an expansion in the stock value. Other outcomes of the study
propose that a firm with large assets and minimum un-systematic risk that is huge
in connection to its future prospects and opportunities might experience a lower
cost of valuable capital (in light of the fact that of a lower stock beta) when the
risk management of working income is reduced ((Fazzari et al., 2000)). While the
result would be opposite when asset value of some insurance firm is small as com-
pared to the value of future prospects. There is a strong statistical relationship
between the total risk and the beta, which also have an effect on the market value
of the firm. So it can be said that there is an indirect relation between the firm
value and un-systematic risk as well, according to the results suggested by the
previous studies.
H4 : Firm-specific risk inversely significant effects to the firm value.
2.5 The Effect of Size (Total Assets) on Firm

Value
Firm size is one of the indicators of the good growth of the firm as this variable
has an effect on the firm value and performance. A big firm with a large number
of total assets is a signal of good growth of the firm and attracts the investors
as well, which results in the increase in the market value of the firm. A big firm
ensures the better profitability and the idea of big profit accomplishment in the
future could result from the increase in the stock prices of the firm which is di-
rectly linked to the firm value. Pandey and Chotigeat (2004) argue that capital
structure and size directly affect the firm value. A study done by (Berger and
Di Patti, 2006) suggests that firm value is associated with the size of the firm.
Firms and companies are usually controlled by the majority shareholders who can
be made changes in the firms policies and management and tend to align their
interest with the outside investors in the growth of the company and their wealth
(Lopez, (1999). The results suggest that when the interest of shareholders who
control the company are perfectly aligned with the outside investors, it helps in
growing the total assets and size of the firm which would consequently have the
positive impact on the market value of the firm.
Rajan and Zingales (1995) integrates four variables to determine their relation-
ships with capital structure, and finds a positive relationship between size and
Tobin Q. Rajan and Zingales (1995) Huang (2006) also report a positive relation-
ship between Tobin Q and size for the firms in China. Anwar and Sun (2013)
report a negative relationship between size and Q of Firms. Harris and Raviv
(1991) state that there is the positive relationship between size and firm value
(Tobin Q) because larger firm are highly diversified and they tend to finance them
through external financing as well, which allows them to reach their target capital
structures. Loof (2004) also argue that large-sized firms adjust more quickly to
their capital structure.
Nivorozhkin (2004) argues that there is the negative relationship between size and
Tobin. Karadeniz et al. (2011) done a study to see the indirect relation of firm size
to the firm value. The study suggests that an optimum capital structure affects
the firm value and there is a significant relationship between them. So, it can be
said that the firm size and good reputation via optimum capital structure might
help to increase the firm value.
Rajan and Myers, (1998) find out that controlling shareholders of the company
tend to invest the liquid assets to grow the size of the company and to increase
its total assets, which ultimately lead to the good reputation of the company due
to which outside investors are attracted and the market value of the firm also
increase. So it can be said from the literature studies that size or total assets of
a firm have an impact on the growth of the Tobins Q and market value of the firm.
2.6 The Effect of Return on Assets on Firm Value
Return on assets (ROA) is considered to be one of the main factors on which mar-
ket value mainly depends. Literature studies depict the association of ROA on
firm value and performance. Asiri and Hameed (2014) formed a model and study
the relation of various variables and ratios with the market value of a firm. The
results suggest that smaller firms and their market value is usually explained by
three factors, i.e. Return on assets, beta of the firm and financial leverage. While
the firm value of large firms is usually depicted and statistically explained by the
ROA and Financial Leverage. Regardless of the sector in which a firm operates,
investors usually take an interest in the profitability of a company by analyzing
the ROA and the financial leverage of the firm.
Beaver, (1989) argue and studies the return on assets as a profitability measure
which attracts or repels an investor thus partially explains and depicts the market
value of the firm. Return on assets provides a valuable framework to analyze the
performance of a firm in a long run. Following the ROA trajectory and the insights
play an important role in determining the firm value in the long-term.
Khatab et al. (2011) conducted a study to find the relation between the prof-
itability of commercial banks and their liquidity for the better understanding of
effective liquidity management impacts. The study argues that the return on as-
sets (ROA) is significantly associated only with the liquid ratio. Moreover, the
results from the studies also suggest that ROA can also be affected by the quick
ratios and current ratios. The empirical studies of previous literature find out that
each variable (ratio) has an impact on the return on the assets that had affected
the market value of the firms. Based on these results, a hypothesis can be made
that return on assets (ROA) has an impact on the Tobins Q. The effect of Re-
turn On Assets (ROA) to Tobin’s Q, populations to be studied in this research is
a meal and beverage are covered within the Indonesia Stock Exchange (BEI) in
2007-2011, the time horizon of 5 years of studies via a sampling approach in this
take a look at turned into a purposive sampling method, the method of analysis
used descriptive records and simple linear regression analysis. The consequences
of the have a look at, the value of the effect on Tobin’s Q ROA of 14.6% and
ROA outside factors that have an effect on Tobin’s Q of eighty-five. Four percent
Return on Assets (ROA) full-size effect on Tobin’s Q.
Lakonishok and Shapiro (1986) research the historic courting for the duration
1962-1981 among inventory marketplace returns and the following variables: beta,
residual preferred deviation (or general variance), and length. They conclude that
neither the conventional measure of danger (beta) nor the alternative hazard mea-
sures (variance or residual widespread deviation) can explain the cross-sectional
variation in returns; best length appears to count. When January returns are
eliminated, even the dimensions variable loses its statistical importance.
2.7 The Effect of Leverage on Firm Value
There is a very little or no significant piece of evidence of a relationship between

capital structure and firm value. Change in capital structure hardly have any
effect on the firm value, but a recent test on optimal capital structure suggest
that as attributed to the debt tax shield effect, the capital structure is associated
with the leverage and the reported evidence signifies a positive relation in optimal
capital structure (Miller and Modigliani, 15). The firms that were examined in
the study (Miller-Modigliani) were all regulated firms that might suggest that the
association of the capital structure to the firm value were caused by the regulatory
working environment of the firms and the findings do not clearly depicts a clear
and significant association of these parameters. Since the optimal capital structure
study by Miller-Modigliani, there is no empirical literature that clearly shows the
association of change in capital structure with the size of its debt tax shield and
firm value. A recent study examined the two forms of capital structure change
that are re-capitalization and issuer exchange offers. The result signifies a positive
relation between stock prices and firm value of the leverage and debt level Masulis
(1983). Debt level changes affect the firm value, as the hypothesis suggests in the
study and the evidence is consistent with the optimal capital structure model.
Previous empirical studies suggest that most of the capital structure theories ar-
ticulate by capital structure choices have a significant relationship between them
and are also indirectly related to the Tobins Q and market value of a firm. An-
other study done by Myers (1984) uses the results from (Brealey, and Donaldson,
1961) to evidently back the hypothesis that firms usually tend to raise its capital
structure in terms of debts, retained earnings and from implementing new equities,
that also affect the firm value. So it can be concluded from the aforementioned
studies that there could be a positive impact of raising the capital structure on
the market value of the firm. Furthermore, profitability and capital structure can
also be correlated as suggested by (Majluf and Myers, 1984) which can also have
an indirect relation with the firm value. The effect of alternate in debt degree
a company values. Two sorts of capital shape alternate are examined: provider
change offers, and recapitalizations. The effects indicate that both stock costs and
firm values are positively associated with adjustments in liability degree and lever-
age; protection prices are adversely relationship of these capital shape alternate
variables. This suggestion is regular with the fashions of most effective capital
structure and with the speculation that debt degree changes launch information
approximately modifications in company value.
Eli et al. (2007) estimated the linkage of Research and Development and capital
structure and firm value. They investigate these relationships in different time
horizon and across the sectors. They used sales debt to equity ratio capital ex-
penditure over the sale, its called growth opportunity research and development
over advertising expenses as the independent variable and firm value depends vari-
able. The results show capital expenditure significantly affect the firm value in
this study different method of regressions apply and the results show that R&D
expenditure played a vital role regarding firm value.
With a like ideal model used by (Kothari et al. (2002)), they find out for the large
sample that research and development and capital expenditure displays huge out-
come on the unpredictability of upcoming income the measure of an organizations
risk engaged here than capital expenditures. So this outcome observed by capital
expenditure and research and development industries and normally both expendi-
tures not done by many companies at a time. Their results are alien to the history
of main technological and scientific development industries. Serve the sample of
an early duration of (1972-1985) and a late duration (1985 to 2000). They also
find that the large link of capital expenditures with firm value and earnings of the
firm when earnings increase also understood that the value of the firm enhances
rapidly. This study represents in late duration the research and development and
capital expenditures greater than the period of 1972-1985).
The confirmation is also reliable with the knowledge that in the United State finan-
cial conditions and the economy as an entire here was a swing in the relationships
among Research and development and capital expenditures at that time the revo-
lution in it.it also introduced and extended a hole in the risk allied with these two
significant events. Additional suggestion concerns United State generally accepted
accounting principles for CAPITAL expenditures and research and development
expenditures. The prior investigation, such as (Lev and Sougiannis (1999)) has
claimed for altering generally accepted accounting principles in courtesy of giving
research and development as CAPEX by requiring capitalization of research and
development.
Kothari et al. (2002) argued against any such type of capitalization. This in-
vestigation delivers confirmation that Capital expenditure and researches and de-
velopment (R&D) expenditures have great, positive and reliable impacts on the
value of the respective organizations. Sydler et al. (2014) like info on present cash
flows, statistics on marketing and R&D expenditure seem to assistance stockhold-
ers form suitable opportunities regarding the scope and inconsistency of future
cash flows. As a consequence, expenditure on marketing and R&D can be ob-
served as a method of investment in intangible assets with probably optimistic
effects on upcoming cash flows. While the significant market value effects of ad-
vertising and generally parent, or all COMPUSTAT database firms, such collective
sign has the possible too vague expressive changes across firm size modules and
industry.
2.8 The Effect of Growth Opportunity on Firm
Hubbard and Bromiley (1994) performed studied and the study result suggests
that growth opportunities is the most common objective and an important fac-
tor mentioned by the top managers in the survey. Growth opportunity play an
important role in determining the line of action for the firm by the top managers
and the variable is associated with the market value of the firm as suggested by
the previous literature studies. Kaplan et al. (2001) Norton and Kaplan (92, 93,
1996) studies these variable and argue that a wide range of goals must be set by
the firms including sales growth to efficiently reach the financial objectives of the
firm and to increase the market value of the firm.
Carlsson and Eliasson (1994) Eliasson, (1987) argues that planning system of a
firm and to provide a visible and useful benchmark for the managers in order
to motivate them, the system generally starts from setting the sales targets and
emphasis on sales growth is partially associated with the firm value. Growth op-
portunities play a central role in Agency theory and according to this theory, sales
growth plays an important role for the personal benefits of managers as it increases
the cash flow and guarantee the employment of managers which also results in the
increase in the salaries due to greater management responsibilities but the theory
and this research failed to determine a clear relation between growth opportunity
or sales growth with the performance of the firm.
Rumelt and Wensley (1981) Rumelt and Wensley, (1981) find out that growth
opportunity influences the profitability because of some unobserved variables and
market share growth also correlate with the returns. Summarizing the literature
studies gives only a partial picture of the sales growths association with the firm
value and performance. There could be more sales and an increase in total sales
but a decline in the market share of the firm in a growing industry. Similarly,
the previous literature investigates that sales growth does not always result in the
increase in returns to the stock holders (Jensen (1993)).
2.9 The Effect of Advertising to Sale Ratio on

Firm Value
Advertising and other marketing variables also affect the firm performance and it
is an important variable that needs to be understood by the analysts, managers,
and researchers. It is evident from the study that firm managers make advertising
decisions and physical capital investment in advertising to increase the firm value.
As per the neoclassical theory of the investment, the only backlash in the model
is the presence of two capital inputs and their adjustment costs. Liu et al. (2009)
Whited, Liu, and Zhang, (2009) presented a model and building on this model,
the marketing variables such as advertising to sale ratio and physical capital in-
vestment are found out to be positively associated with the firm value.
The advertising and sales have a positive effect on the firms market value and the
high advertising to sales ratio result in the increase in firm value and high average
stock returns. Moreover, (Joshi and Hanssens (2010) (Joshi and Hanssens, 2010)
studied the relation between firm performance and advertising intensity and the
results of the study suggest there is a positive relationship between these variables.
Chauvin and Hirschey (1993) performed a study and finds out that research & de-
velopment, and advertising expenditures have a consistent large positive influence
on the firm value and its future cash flow.
Conchar et al. (2005) Investigated positive impact of advertising on the firm value
and the performance. In a recent empirical study, the relation between firm mar-
ket value and advertising & sales comes out to be positive using the OLS (Qureshi,
2007 Siong 2010) used the OLS reports to study the relationship between market-
ing variables such as advertising and capital investment and the results suggest a
statistically positive influence of marketing variables on the market value of the
firm. Kundu et al. (2010) compiled and used the date of more than 150 firms and
finds out that Tobins Q is positively related with the advertising expenditures and
there is a significant relationship between these variables.
Chapter 3
Data Description and

Methodology
3.1 Data Description
The current study aims to explore the impact of Earning volatility, Cash flow
volatility on firm value for 60 non-financial companies listed at Pakistan Stock
exchange. The sample period is about 15 years from 2003 to 2017. Firms with
incomplete financial data are not included in the sample; because they cannot
serve as the purpose of the study, as well as all proxies, cannot be applied to
incomplete data. Only non-financial companies are used for analysis because the
year closing of non-financial companies in 30th June whereas the year closing of
financial companies is end of December and, also the capital structure of non-
financial firm is different and all other decisions of a financial sector are well
regulated and significantly different from the companies in non-financial sectors
((Bassey et al., 2014). At the same time, this study can be used in the financial
sector as well by making some fundamental changes. The tests are based on
lagged and forward year information. That’s why few years observations are lost
in regression.
36
Research Methodology 37
3.2 Panel Data Analysis
Panel data analysis is used when the data has both cross-sections and time series
Data, same applies to this study. There are three different models used in panel
data analysis. Each has a different assumption regarding the intercept. The first
model of the common coefficient has constant intercept across all cross sections
and time Period. The second model is the Fixed Effect Model which describes
that the intercept is different for all cross-sections. The third one is a Random
Effect Model, in which the intercept is different for all the cross sections along with
random over time. Two different tests are used to determine which of the three
models should be used for application in panel data analysis. The Fixed Effect
Redundancy test is used to identify which of the two models of the common coef-
ficient model and the fixed effect model can be applied. If the result is significant
in the case of this test, then the fixed effect model has used, but if the result is
insignificant then the common coefficient model will be used. The Hausmen test
is used to determine which of the two models of the fixed effect model and the
Random effect model should be used for the study. If the result of this test is
significant, then fixed effect model has used and in case of insignificant results, the
Random effect model has used for the analysis of data.
H0: Common effect model is relevant .

H1: Fixed effect model is relevant.
If the answer is significant the reject the null hypothesis and if the answer is in-
significant the use fixed effect model.
H0: Random effect model is appropriate.

H1: Fixed effect model is appropriate.
If the answers is significant than reject the entire null hypothesis and if the answer
is insignificant, then use null hypothesis. In this study the answer is significant so
use fixed effect model.
3.3 Sources of Data
In this study secondary data is used for analysis. Annual data is used for analysis.
Only those companies are selected which companies closing date is 30th June. The
data for other variables are collected from the annual financial statements of firms.
The Data is collected from the following sources:
• Pakistan Stock Exchange website, PSX
• Business recorder website
• State bank of Pakistan website
• Websites of companies used in the analysis
• Scs Trade
Table 3.1: No. of Companies and Respective Industries
No Sector Names Number of Companies

1 Cement 12
2 Textile Spinning 3
3 Pharmaceutical company 4
4 Chemical 5
5 Oil & Gas Marketing Companies 3
6 Glass 2
7 Engineering 4
8 Technology & and Communication 2
9 Sugar Industry 5
10 Automobile Assembler 2
11 Cable & Electrical Goods 2
12 Fertilizer 1
13 Miscellaneous 4
14 Paper & Board 1
15 Food & Personal Care Products 7
16 Transport 1
17 Tobacco 2
Total 17 60
3.4 Control Variables
Prior work suggests that there are many other factors which are the effect the
firm value. Lang and Stulz 1994) and Allayannis and Weston (2001), The fixed
effect examinations control for other determinants that theory recommends and
previous empirical work has revealed, to has an important effect on firm value.
These variables are control variables because the previous literature shows these
also affect the firm value.
Variables Proxy Measured By
Size Log Total Asset Log Of total Assets
Profitability Return on Assets Net Profit/ Total Assets
Growth Opportunity CAPEX Capital Expenditure to sales
Leverage Capital Structure Debt To Equity Ratio
ATS Advertising to sale Advertising Expenditures over sales
3.5 Measurement of Variables
3.5.1 Dependent Variable
3.5.2 Tobin Q
Where TQ, dependent variable in the study, which is the value of the i firm in
time t and it is calculated by the ratio of the market value of the equity and
total book value of liability to net assets. I have taken net assets, including long
term and short term. The value of the company is defined as the total worth of
the company. It has also been calculated by the market capitalization. Q is the
proxy of firm value Utilize the market-to-book ratio to calculate Q. It is computed
total number of shares multiplying by its market price of the end of the fiscal year
(market price of the Equity) plus the book value of long-term liability and divided
by total assets of the firm, for the market value of equity (Shin and Stulz 1999).
M P SN OS+LT D
T obinQ = T.A
MPS = Market price of the share.

NSO = Number of the share outstanding which are reported in companies Finan-
cial Statements.
LTD = LTD is Long term debt obligations.
T.A = T.A is a total asset which firms hold to generate revenue.
3.6 Independent Variable
3.6.1 Estimation of Earnings Volatility and Cash Flow Volatil-

ity
The common method is for estimation a time-series model for earnings and cash
flows, and computes the time-series volatility only for the stationary component
of the data. There is an massive work in accounting (see, e.g., Brown (1993) and
references therein) suggesting that usually, earnings are strongly tenacious and
show seasonality. To justification for such time-series properties, I have estimated
a model of earnings and cash flows that accounts for this persistence with lagged
values of earnings and cash flows, as well as quarterly dummy variables. Our
estimation equation for each firm is:
4
P
Et = α + β1 Et−1 + βq 1quater + t
q−1
Earnings volatility is calculated through the standard deviation of the quarterly

earnings of the company. Quarterly earnings collected based on earnings per share
from operations. There are minimum 36 values for each company and maximum
60 values. First of all, monthly values of quarterly earnings from operations taken
from the financial statements of the companies. Dummy variables are created for
each year and each firm. Then through equation find out residual to avoid the
seasonality because earnings are persistent and exhibit seasonality. After finding
out of residual, then calculated the standard deviation of each year and taken the
values of Q4 to use as Earning volatility (see e.g., Brown 1993; (Albrecht and
Richardson, 1990); Michelson, Jordan-Wagner, and Wootton, 1995
In this model the constant term, , along with the AR (1) coefficient captures serial
association and any time-series tendency in earnings. This study has estimated
the above model for each firm individually based on our full sample of fifteen years
of quarterly earnings data (2003-2017). Using the results from this regression for
each firm, computed the sample standard deviation of the estimated residuals.
Volatility of earnings = Stdev (t )
3.6.2 Earnings Volatility
EV is the Earning volatility of i company at the time t. Many proxies are used by
the researcher to measure earning volatility, but in this study used the standard
deviation of quarterly earnings. Earning volatility means how steady and unsteady
earning of the firms. The residuals of the quarterly earnings per share, which is
estimated using this equation.
4
P
Et = α + β1 Et−1 + βq 1quater + t
q−2
Then
Volatility of earnings = Stdev (t )

3.6.3 Cash Flow Volatility
Cash Flow volatility means that cash flow volatility refers to the amount of un-
certainty or risk related to the cash flows from operations. A higher volatility
means companies net operating cash flows are highly unpredictable and unstable.
It means firms can face the shortage of the cash flows dramatically over a short
time period in either direction. A lower volatility means that cash flows not fluc-
tuate dramatically, and tends to be steadier.
Cash flow volatility is calculated through the standard deviation of the quarterly
cash flow of the company. Quarterly cash flow collected based on net cash flow from
operations ((Minton et al., 2002)). There are minimum 36 values for each com-
pany and maximum 60 values. First of all, monthly values of quarterly cash flow
from operations taken from the financial statements of the companies. Dummy
variables are created for each quarter of each firm. Then through equation find
out residuals to avoid the seasonality because cash flow is persistent and exhibit
seasonality. After finding out of residuals then find the standard deviation of each
year and taken the values of Q4 to use as cash flow volatility. We can also utilize
the coefficient of variation as in Minton and Schrand, (1999).
4
P
CF Vt = α + β1 CFt−1 + βq 1quater + t
q−2
Then
Volatility of Cash flows = Stdev (t )
CFV = Standard Deviation of Residual of Quarterly Operating Cash flows.
3.6.4 Systematic Risk
SR is the Systematic risk of i company in the time t. The systematic risk is

the un-diversified risk which cannot be eliminated, but can be minimized through
diversification. To calculate Systematic risk monthly values of the share prices
are collected and Constructed as beta squared multiplied by the variance of the
market return. This measure follows the same construction as for the other market
risk measures.
rit = α + βj rmt + ij
rij =is the log return of firm j for day i and rm i is the log return of the CRSP
value-weighted index for day i. this study report results using ordinary-least-
squares estimates of the market model. Systematic risk is the product of bj and
the variance of the value-weighted index return. Unsystematic risk is the variance
of eij. Entire risk is the amount of systematic risk and unsystematic risk.
3.6.5 Beta
Beta is the measure of systematic risk. The market model is used to calculate Beta
for the firms. In market model, 3 years monthly returns of Pakistan stock exchange
value-weighted index used to calculate Beta. For example, in this study required
Beta for the firm, for the year of 2003 then there are used monthly returns of the
value-weighted index and firm between the periods of 2000 to 2003, (36 months
values of returns used to calculate beta for the year of 2003 to onward).
3.6.6 Firm-Specific Risk
Type of risk which is solely related to the firms, which firms stockholders invested.
This risk is not diversified. Firm-Specific Risk is computed as the residual risk
from the market model as in (Shin and Stulz, 2000).
3.6.7 Return on Assets (ROA)
Return on assets is a ratio which tells investors about the financial performance of
the company. It is calculated by using net profit divided by Total Assets. Its also
defined that how companies are efficient using their resources to generate profit.
N.P
ROA = A.T.A
Whereas
N.P = N.P is net profit which firms generate over the year form the usage of
resources which companies own.
A .T.A = Average total assets are calculated plus the previous 2 years value of
total assets and divided by 2.This item represent the average value of the assets.
This is the Company annual data shows current assets plus property, plant, and
equipment, plus other non-current assets (including intangible assets, deferred
charges, and investments and advances.
3.6.8 Capital Expenditures
This item represents that amount which companies are spending to acquire up-
grades, enhance the technology of their assets. In this expenditure, buildings,
equipment and new project and investment are included.
Capital Expenditure = PPE Current year - PPE Previous year + Depreciation
3.6.9 Long-Term Debt
Long term liabilities include the debt obligations which are due more than one
year from the firm’s balance Sheet date or due after the current operating cycle.
3.6.10 Market Risk
The standard deviation of the Pakistan Stock exchange value-weighted market

return based on three years of monthly returns over the preceding three years of
the observation unit.
3.6.11 Size
The size is calculated through the log of total assets of the firms. ((Kumar and
Waheed, 2014)).
3.7 Methodology
This study used the least square method to check the relationship of earnings
volatility and cash flow volatility on the value of the firm accompanied by other
variables. I formed the linear equation on the basis of the literature review, which
this study has done in the previous chapter and test those factors which play an
important role in the value of the firm.
3.7.1 Earnings Volatility and Firm Value
(ln)T Qit = β0 +β1 (ln)CF Vit +β2 (ln)SRit +β3 (ln)F SRit +β4 (ln)T Ait +β5 ROAit
+ 2β6 GOit + β7 CSit + β8 AT Sit + t
(3.1)
3.7.2 Cash Flow Volatility and Firm Value
(ln)T Qit = β0 +β1 (ln)CF Vit +β2 (ln)SRit +β3 (ln)F SRit +β4 (ln)T A(it)2 +β5 ROAit
+ 2β6 GOit + β7 CSit + β8 AT Sit + t
(3.2)
Whereas
(ln)T Qi,t = Log of Tobin Q which is the proxy of firm value.
(ln)CF Vi,t = Cash flow volatility.
(ln)EVi,t = Log of Earnings volatility.
(ln)SRi,t = Log of Systematic Risk.

(ln)F SRi,t = Log of Firm Specific Risk.
(ln)T Ai,t = Log of total.
ROAi,t = Return on assets.
CSi,t = Leverage ratio (debt to Equity ratio).
AT Si,t = Advertising to sales ratio.
Prior research shows earnings and cash flow volatility is measuring the same phe-
nomena due to this reason. Allayannis and Weston (2001) they find that CFV has
an adverse result on firm value in all of their examinations, (they are unable to find
a similarly negative effect for earnings volatility at the same time). These results
are robust to several alternative measures of earnings volatility as well as more
direct measures of earnings smoothing like the ratio of earnings volatility to cash
flow volatility and the association between contemporaneous changes in accruals
and changes in cash flows ((Leuz et al., 2003)) In cross-sectional tests, they find
that generally cash flow volatility has a negative effect on Firm value. However,
in other time-series, or panel tests, cash flow volatility is often insignificant, while
earnings volatility remains strongly significant (and negative). This horserace”
regressions between earnings and cash flow volatility yield an interesting result.
Rountree et al. (2008) test, earning volatility and cash flow volatility in 2 different
equations.
3.8 Variance Inflation Factor (VIF) Test
If the correlation between independent or predictor variables is very high, then

the issue of multicollinearity arises and it may affect the regression results because
instead of affecting the dependent variables independent variables start effecting
each other and overall results get affected. The check the multicollinearity issue
VIF variance inflation factor is used.
Chapter 4
Data Analysis and Discussion
4.1 Descriptive Statistics
The descriptive statistics show the behavior of data. Statistical behavior of data
panel. Data of the independent variables and dependent variables for the period
of (2003 to 2017) is presented in Table 1. The summary statistics about Tobin
Q shows the mean value is 1.41927 of Pakistan firms. The minimum value of
Tobin Q is 0.51768 and maximum value of Tobin Q is 2.98931 while the standard
deviation of T-Q is 0.65648. EV is earnings volatility the mean value of earning
volatility is 5.51107 while the standard deviation of EV is 8.77756. The maximum
and minimum values of earning volatility EV are 66.80348 and 0.098342. CF is
the abbreviation of cash flow. The value of standard deviation of CF is 119.6035
while the average value of cash flow is 34.38334. The minimum value of CF is
0.022206 and maximum value of cash flow CF is 1981.808. The minimum and
maximum value is highly variation with each other. SR shows the systmatic risk.
The average value of SR is 0.007309 while the maximum and minimum values of
SR are 0.052393 and 0.008876. The standard deviation of SR is 0.00824. FSR is
a firm specific risk. The standard deviation of FSR is 0.167532 and mean value of
firm specific risk FSR is 0.063879. The maximum value of FSR is 1.317367 and
minimum value of firm specific risk is 0.00000000116 there is a highly variation
between maximum and minimum values. T-A show the total assets of firms. The
average value of total assets T-A is 18.8769 while the minimum and maximum
47
Results 48
Table 4.1: Descriptive Statistics for the Period of the 2003-2017
Variables Mean Median Maximum Minimum Std. Dev.
T-Q 1.41927 1.26846 2.98931 0.51768 0.65648
EV 5.511077 2.800438 66.80348 0.09834 8.77756
CFV 34.38338 0.831323 1981.808 0.02221 119.604
SR 0.007309 0.005155 0.052393 0.0089 0.00824
FSR 0.063879 0.018036 1.317367 1.20E-09 0.16753
T-A 18.87692 5.070014 324.1868 0.41271 40.1572
ROA 7.131465 3.523303 67.58851 -17.642 11.7319
CS 1.9537 1.2607 32.0055 0.0072 4.8251
GO 0.156434 0.065635 7.471473 -4.0764 0.82711
ATS 0.08232 0.00119 7.9446 0.0000 0.47658
Note: This table shows Descriptive statistics for various independent variables and dependent
variables. The dependent variable is Tobin q which the proxy of firm value. The independent
variables are Ev is the earning volatility of the firms CFV is cash flow volatility. SR is the
systematic risk which calculated using Beta. FSR is the firm specific risk which solely related to
firms: T-A is the size of the firms which is equal to log of total assets. ROA is the rerun on
asset which is net profit over total assets. GO is the growth opportunity which is Capx over sales
CS the capital structure of the firms. ATS IS the advertising expense over sales. While CFV is
scaled by 1 million and total assets are scaled by 10 million.
Results 49
values of T-A are 0.41271, 324.187 and Standard deviation of total assets T-A is
40.1572. ROA means the return on assets. The maximum value of ROA 67.58851
and minimum value of ROA is -17.64238 while the standard deviation of ROA
is 11.73194. The average value of return on assets ROA is 7.131465. CS shows
the capital structure. The average value of capital structure CS is 1.9537. The
Standard deviation of CS is 4.8251 while the minimum and maximum values of
capital structure CS are 0.0072 and 32.0055. GO shows the growth. The standard
deviation of GO is 0.87112 while the minimum and maximum values Of GO are
-4.076374 and 7.471473. The average value of the GO is 0.156434. The mean value
of ATS is 0.08032. Standard deviation of ATS is 0.47658. The maximum value of
ATS is 7.9446 and minimum value of ATS is 0.0000.
Results 50
4.2 Correlation Matrix
The table 4.2 shows Tobin q is positively correlated with earning volatility 0.124.
Tobin q is negatively correlated with systematic risk and firm specific risk -0.132,
-0.083. Cash flow and total assets are negatively correlated with Tobin q -0.029,
-0.168. Tobin q is positively correlated with return on assets and advertisement
to sale 0.305, 0.104. CS and growth opportunities are negative correlated-0.096,
-0.036 with Tobin q. EV is negatively correlated with cash flow -0.048. Systematic
risk and total assets are negatively correlated with earning volatility -0.159, -0.069.
EV is positively correlated with firm specific risk and return on assets 0.167, 0.198.
Advertisement to sale is positively correlated 0.021 with earning volatility. Earning
volatility is negatively correlated with capital structure and growth opportunities
-0.008, -0.038. Systematic risk and firm specific risk are negatively correlated with
cash flow -0.064, -0.047. Cash flow is positively correlated with total assets 0.156.
Return on asset is negatively correlated with cash flow -0.085. Growth opportuni-
ties and advertisement to sale are positively correlated with cash flow 0.043, 0.017.
Cash flow is positively correlated with capital structure 0.001. Systematic risk is
positively correlated with firm specific risk 0.102. Total assets and return on as-
sets are negatively correlated with systematic risk -0.040, -0.085. Systematic risk is
positively correlated with capital structure and growth opportunities 0.045, 0.037.
Advertisement to sale is negatively correlated with systematic risk -0.086. Firm
specific risk is positively correlated with total assets and return on assets 0.045,
0.061. Capital structure and advertisement to sales are negatively correlated with
firm specific risk -0.049, -0.038. Firm specific risk also negatively correlated with
growth opportunities -0.002. Total assets are negatively correlated with return on
assets and advertisement to sale -0.040, -0.027. Growth opportunities and capital
structure are positively correlated with total assets 0.035, 0.339. Return on assets
is negatively correlated with capital structure and growth opportunities -0.160,
-0.029. Advertisement to sale is positively correlated with return on assets 0.021.
The capital structure is negatively correlated with growth opportunities and ad-
vertisement for sale -0.018, -0.043. Advertisement to sale is negatively correlated
with growth opportunities -0.100.
Results
Table 4.2: Panel-correlation of Earning, Cash flow volatility and other variables for the period of 2003 to 2017
T-Q EV CF SR FSR T-A ROA CS GO ATS

T-Q 1
EV 0.124 1.000
CFV01 -0.029 -0.048 1.000
SR -0.132 -0.159 -0.064 1.000
FSR -0.083 0.167 -0.047 0.102 1.000
T-A -0.168 -0.069 0.156 -0.040 0.045 1.000
ROA 0.305 0.198 -0.085 -0.085 0.061 -0.040 1.000
CS -0.096 -0.008 0.001 0.045 -0.049 0.035 -0.160 1.000
GO -0.036 -0.038 0.043 0.037 -0.002 0.339 -0.029 -0.018 1.000
ATS 0.104 0.021 0.017 -0.086 -0.038 -0.027 0.021 -0.043 -0.100 1.000
Note: : This table shows correlation for various independent and dependent variables. The dependent variable is Tobin q which the proxy of firm value. The
independent variables are Ev is the earning volatility of the firms CFV is cash flow volatility. SR is the systematic risk which calculated using Beta. FRM is
the firm specific risk which solely related to firms: S is the size of the firms which is equal to log of total assets. ROA is the rerun on asset which is net profit
over total assets. GO is the growth opportunity which is Capx over sales CS the capital structure of the firms. ATS IS the advertising expense over sales.
51
Results 52
4.3 Multicollinearity Check of the Independent

Variables for the Period of 2003 to 2017
If the correlation between independent or predictor variables is very high, then

the issue of multicollinearity arises. It may affect the regression results because
instead of affecting the dependent variables independent variables start affecting
each other. So, overall results get affected. The check the multicollinearity issue
VIF variance inflation factor is used.
Table 4.3: Variance Inflation Factors of the Earning volatility, Cash flow
volatility and firm value.
Variable Coefficient Uncentered Centered

Variance VIF VIF
C 0.067 3.332 NA
EV 0.000 1.544 1.107
CFV 0.000 1.125 1.039
FSR 0.761 1.213 1.059
SR 0.890 1.907 1.067
T-A 0.000 1.230 1.172
ROA 0.000 1.479 1.080
CS 0.001 1.264 1.036
GO 0.034 1.187 1.146
ATS 0.090 1.041 1.020
Note: This table shows (VIF) Variance Inflation Factors for various independent variables. The
dependent variable is Tobin q which the proxy of firm value. The independent variables are Ev
is the earning volatility of the firms CFV is cash flow volatility. SR is the systematic risk which
calculated using Beta. FRM is the firm specific risk which solely related to firms: S is the size
of the firms which is equal to log of total assets. ROA is the rerun on asset which is net profit
over total assets. GO is the growth opportunity which is Capx over sales CS the capital structure
of the firms. ATS IS the advertising expense over sales When the centered value of VIF is less
than 5 there is no concern of multicollinearity. If the centered value is more than 5 there is a
problem of multicollinearity that must be resolved before running the regression equation. The
centered value of EV CFV SR FSR T-A ROA GO ATS is less than 5 are which means there are
no concerns of multicollinearity in the data. These variables can be regressed simultaneously.
Results 53
4.4 Diagnostics Test
As it is a panel data analysis, so it becomes important which of the models in the

panel analysis is being used in this study. There are two different models, Com-
mon Coefficient model, fixed effect model. Each of these has different assumption
in relation to the nature of the data with respect to time and cross section. For
opting one of these models the Redundant Fixed effect test is used to identify
either the constant coefficient model or the fixed model is to be used for the study.
If the results are significant then fixed effect model is used, but if the results are
insignificant, then the common coefficient model is used. As the test results are
significant so the fixed effect model is opted between these two.
Table 4.4: Redundant Fixed Effects Tests.
Redundant Fixed Effects Tests Statistic d.f. Prob.
Cross-section F 6.34 -59559 0
Cross-section Chi-square 321.13 59 0
Table 4.5: Random Effect Model.
Test Summary Chi-Sq. Statistic Chi-Sq. d.f. Prob.
Cross-section random 25.543521 8 0.0013

Results 54
4.5 The Results of Fixed Effects Model for Earn-

ing Volatility
The value of determination coefficient (R2 = 0.5279) indicates that the model
has strong explanatory power. The value of adjusted coefficient of determination
(Adj. R2) = 0.4726 that the independent variables explain 47.26% variation in
Dependent variable. Moreover intercept is significant (0.0000) that indicates the
probability of omitted variables. It means there are various variables which are
included in this study but there are also some variables which may impact Tobin
q which is the proxy of firm value but are not included in this study. In model
1 only without risk variables included. Model 2, firm specific risk in model 3
systematic risk included. In model 4 all the 3 variables of risk added. As model
1 show; most of our control variables are significant and have the same signs
as in the literature. The ATS and growth are insignificant, This first variable
which significantly impacts the Tobin q is Ev, with p-value 0.0428, The coefficient
of Ev had value of -0.052335, this negative value along with p-value indicates
a significant and negative relationship between Ev and Tobin Q Above result is
the according to the expectations that volatility in financial statements negative
impact on firm value (Trueman and Titman 1988; Brennan and Hughes 1991;
Lang, Lins, and Miller 2002; and Badrinath, Gay, and Kale 1989; Allayannis
Weston 2003). The SR also has significant relationship with the Tobin q with a p-
value of 0.0791, but the coefficient of SR has a value of 0.215087, which indicates a
Positive relation between SR and proxy of firm value. These results are consistent
with the literature included in this study such as research by Shin and Stulz (2000).
The size also has significant relationship with the Tobin q with a p-value of 0.0032,
but the coefficient of Size has a negative value of -0.0660 which indicates a negative
relation between Size and proxy of firm value. These results are consistent with
the literature included in this study such as research by (Luqman 2017). The
ROA also significant impacts with Tobin q, with a p-value of 0.000, the coefficient
of this variable is 0.025425 which represents positive relationship between ROA
and Proxy of the firm value, and CS significantly impacts Tobin q ratio by having
Table 4.6: Fixed Effect Model Show the impact of Earning Volatility on Tobin Q for the period of 2003- 2017
Results
Fixed Effect model Coefficient Prob. Coefficient Prob. Coefficient Prob. Coefficient Prob.
Intercept 4.2306 0.0000 4.2184 0.0000 4.1249 0.0000 4.2061 0.0000
EV -0.0523 0.0428**
SR 0.2382 0.0515 0.2151 0.0791*
FSR 0.2988 0.8724 -0.5150 0.7866 -0.2490 0.8958
Size -0.0699 0.0014 -0.0693 0.0019 -0.0640 0.0042 -0.0660 0.0032***
ROA 0.0243 0.0000 0.0244 0.0001 0.0252 0.0000 0.0254 0.0000***
GO 0.0129 0.4014 0.0129 0.4026 0.0127 0.4113 0.0109 0.4796
CS -0.0080 0.0111 -0.0080 0.0111 -0.0077 0.0134 -0.0070 0.0259**
ATS -0.0388 0.2220 -0.0387 0.2239 -0.0382 0.2282 -0.0370 0.2420
R2 0.5213 0.5213 0.5245 0.5279
Adj R-squared 0.4680 0.4671 0.4697 0.4726
F stat 9.7836 9.6172 9.5755 9.5454
F sig 0.0000 0.0000 0.0000 0.0000
The dependent variable is Tobin q which the proxy of firm value. The independent variables are Ev is the earning volatility of the firms CFV is cash flow
volatility. SR is the systematic risk which calculated using Beta. FRM is the firm specific risk which solely related to firms: S is the size of the firms which
is equal to log of total assets. ROA is the rerun on asset which is net profit over total assets. GO is the growth opportunity which is Capx over sales CS the
capital structure of the firms. ATS IS the advertising expenses over sales.
55
Results 56
p-value of 0.0259 the coefficient value of CS indicated negative relation between

TOBIN Q and CS as it has value of -0.007004 these result are consistent with
the results of study by (Allayannis Weston 2001, 2003) Rountre et al. (2008).
Growth, Firm specific Risk and Advertising to sales ratio are insignificant relation
with Tobin Q ratio.
Results 57
4.6 The Results of Fixed Effects Model for Cash

Flow Volatility
The value of determination coefficient (R2 =0.527) indicates that the model has
strong explanatory power. The value of adjusted coefficient of determination (Adj.
R2) = 0.472 that the independent variables explain 47.26% variation in Dependent
variable. Moreover intercept is significant (0.0000) that indicates the probability
of omitted variables. It means there are various variables which are included in
this study but there are also some variables which may impact in model 5 only
without risk variables included. Model 6, firm specific risk in model 7 systematic
risk included. In model 8 all the 3 variables of risk added. As Model 1 shows;
most of our control variables are significant and have the same signs as in the
Literature. Same as earning volatility model the ATS and growth are insignificant,
Tobin q which is the proxy of firm value but are not included in this study. This
first variable which significantly impacts the Tobin q is CFV, with p-value 0.073,
The coefficient of CFV had value of -0.039, this negative value along with p-
value indicates a significant and negative relationship between CFV and Tobin
Q Above result is the according to the expectations that volatility in Cash flow
volatility negative impact on firm value (Trueman and Titman 1988; Brennan
and Hughes 1991; Lang, Lins, and Miller 2002; and Badrinath, Gay, and Kale
1989; Allayannis Weston 2003)). The SR also has significant relationship with the
Tobin Q with a p-value of 0.058, but the coefficient of SR has a value of 0.232,
which indicates a Positive relation between SR and proxy of firm value. These
results are consistent with the literature included in this study such as research by
(Shin and Stulz 2000). The size also has significant relationship with the Tobin Q
with a p-value of 0.006, but the coefficient of Size has a negative value of -0.061
which indicates a negative relation between Size and proxy of firm value. These
results are consistent with the literature included in this study such as research
by (Allayannis Weston 2001; Luqman 2017). The ROA also significant impacts
with Tobin Q, with a p-value of 0.000, the coefficient of this variable is 0.026 which
represents positive relationship between ROA and Proxy of the firm value, and CS
Table 4.7: Fixed Effect Model Show the impact of Cash Flow Volatility on Tobin Q for the period of 2003- 2017
Results
Fixed Effect model Coefficient Prob. Coefficient Prob. Coefficient Prob. Coefficient Prob.
Intercept 4.231 0.000 4.218 0.000 4.125 0.000 4.638 0.000
CFV -0.039 0.073*
SR 0.238 0.052 0.232 0.058*
FSR 0.299 0.872 -0.515 0.787 -0.543 0.775
Size -0.070 0.001 -0.069 0.002 -0.064 0.004 -0.061 0.006***
ROA 0.024 0.000 0.024 0.000 0.025 0.000 0.026 0.000***
GO 0.013 0.401 0.013 0.403 0.013 0.411 0.012 0.448
CS -0.008 0.011 -0.008 0.011 -0.008 0.013 -0.008 0.012**
ATS -0.039 0.222 -0.039 0.224 -0.038 0.228 -0.040 0.205
R2 0.521 0.521 0.524 0.527
Adj R-squared 0.468 0.467 0.470 0.472
F stat 9.784 9.617 9.576 9.517
F sig 0.000 0.000 0.000 0.000
The dependent variable is Tobin q which the proxy of firm value. The independent variables are Ev is the earning volatility of the firms CFV is cash flow
volatility. SR is the systematic risk which calculated using Beta. FRM is the firm specific risk which solely related to firms: S is the size of the firms which
is equal to log of total assets. ROA is the rerun on asset which is net profit over total assets. GO is the growth opportunity which is Capx over sales CS the
capital structure of the firms. ATS IS the advertising expense over sale.
58
Results 59
significantly impacts Tobin q ratio by having p-value of 0.012 the coefficient value
of CS indicated negative relation between TOBIN Q and CS as it has value of
-0.008 these result are consistent with the results of study by (Allayannis Weston
2001, 2003). Rountree et al. (2008) Growth, Firm specific Risk and Advertising
to sales ratio are insignificant relation with Tobin q ratio.
Chapter 5
Conclusion
The first purpose of study is to examine the impact of earning volatility, cash flow
volatility on firm value using a sample of 60 non-financial firms listed at the Pak-
istan stock market for the period of 2003 to 2017. For this purpose fixed effects
regression model is employed. The proxy of earnings volatility (Standard deviation
of the residual of earning per share from operations and cash flow volatility mea-
sured by the standard deviation of residual of cash flow from operating activities.
The results of the study indicate a significant negative relationship between earn-
ing volatility, cash flow volatility and firm value. Companies with higher earnings
and cash flow volatility have elevated less firm value. The investors are uncertain
about future behavior of the firms, so they tend to avoid these companies which
firms earnings and cash flow volatility is high. . These companies which are facing
large variations in earnings in which companies, Individual and institutional in-
vestors avoid to investing their fund. It is quite evident from previous studies that
smoothness in earnings and cash flow reduces the informational benefit between
insider management and outside investors. High earnings volatility increases neg-
ative earnings disclosures; because when trading volumes are high, then financial
markets will be more informed. This informed trading will help to reduce the
information asymmetries between the insiders and outsiders. This will eventually
put a pressure on insiders to generate smoothness in financial statements. There is
a positive relationship between Systematic risk and firm value. It is quite evident
from the previous studies that market risk positively contributes to firm value.
60
Discussion and Conclusion 61
The third purpose of examine the relationship between control variables firm size
and value of the firm. Size is negatively associated with the firm value Profitability
is positively linked to firm value companies normally return on assets their profits
so if the company is making good profit it will give positive sign to its potential
and existing shareholders. When company will be making less profit it will have
less cash flow available and this cause has directly led towards a shortage of cash
flow, which will enhance the variations in operating cash flows so it will generate
the cash flow volatility. These results are aligned with previous researches Ser-
rasqueiro and Nunes (2008); and Becker-Blease et al. (2010)) they also studied
the association between profitability and firm value. Leverage negatively associ-
ated with firm value. The change in debt to equity ratio augmented the risk of
equity holder then return on equity increase, which leads to decrees the firm value
significantly Rountree et al. (2008).
5.1 Policy Recommendation
On the basis of the findings, it is recommended that firms should keep a check
on the variations over time. In this process the consideration of various factors is
very important. It allows identifying those factors which make the smoothness in
financial statements. Special consideration should be given to the control factors
which impact the firm value of the non-financial firms. The systematic risk which
is usually gives great importance regarding the firm value. This study makes it
clear that the volatility in financial statements influences regarding the Value of
the firm. Being vigilant about only those variables which influence the value of
the firm allows saving time and energy spent by firms in making these decisions
and their implementation. In case of leverage firms should keep optimal debt to
equity ratio. This factor should be kept in view of the non-financial firms when
making capital structure decisions.
Bibliography 62
5.2 Directions of the Future Research
The study may propose the following future directions.
• The Total Risk may also have an impact on firm value. It could be included in
the future study.
• The Use of derivatives may also affect Firm value so it should be Included in
the study.
• Dividend pattern may also affect the firm value it can also be Included in the
study.
• This study is only limited to non-financial companies; pattern of financial firms
shall also be studied
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CAPITAL UNIVERSITY OF SCIENCE AND

The Impact of Earning Volatility

Copyright c 2018 by Muhammad Shahid

This work is dedicated to my beloved parents who have encouraged me to achieve

The Impact of Earning Volatility and Cash Flow Volatility

THESIS EXAMINING COMMITTEE

S. No. Examiner Name Organization

Dr. Sajid Bashir Dr. Arshad Hassan

At any time if my statement is found to be incorrect even after my graduation,

Registration No: MMS-163027

Registration No: MMS-163027

Keywords: Tobin Q, Earning Volatility, Cash Flow Volatility, System-

3 Data Description and Methodology 36

3.5 Measurement of Variables . . . . . . . . . . . . . . . . . . . . . . . 39

4 Data Analysis and Discussion 47

3.1 No. of Companies and Respective Industries . . . . . . . . . 38

4.1 Descriptive Statistics for the Period of the 2003-2017 . . . . . . . . 48

have engaged in considerable smoothness.

volatility. Thus, as with each other economically measure, volatility requirement

1.1 Theoretical Background

• It is assumed that there is no tax. There is no tax difference amid capital

• It is supposed that investment strategy of a company fixes and reinvest the

According to MM model, it is proved that the value of a firm is not influenced

1.2 Research Gap

The companies in Pakistan operate in an uncertain and dynamic environment, for

1.3 Problem Statement

There is vast volatility in financial statements. To examining the influence of

1.4 Research Questions

This study has the following research questions:

1. Does earning volatility have an effect on the Firm Value?

2. Is there cash flow volatility have an impact on the firm value?

3. Does systematic risk affect the Firm value?

4. What is the effect of firm-specific risk on Firm Value?

1.5 Objective of the Study

This study has the following objectives:

• To investigate diversified and un-diversified risk affects the firm value.

1.6 Significance of the Study

1.7 Plan of Study

problem statement, research objective research questions and the significance of

2.1 The Effect of Earnings Volatility on Firm

extraordinary broad rivalry. Different cross-sectional and time-arrangement tests

2.2 The Effect of Cash Flow Volatility and Firm

firm’s anticipated under investment’ fees.

incomes to investors (Melamud, 2002) Specified these opinions, if revenue smoother

value of CF constant as market risk increases Bhagat et al. (2015).

H2 : Cash flow Volatility significant negative associated with firm value.

2.3 The Effect of Systematic Risk on Firm Value

better markdown rates in assessing global plans.

H3 : Systematic Risk is significantly impact to the firm value.

2.4 The Effect of Un-Systematic Risk on Firm

H4 : Firm-specific risk inversely significant effects to the firm value.

2.5 The Effect of Size (Total Assets) on Firm

2.6 The Effect of Return on Assets on Firm Value

2.7 The Effect of Leverage on Firm Value

There is a very little or no significant piece of evidence of a relationship between

2.8 The Effect of Growth Opportunity on Firm

2.9 The Effect of Advertising to Sale Ratio on

Data Description and

3.1 Data Description

3.2 Panel Data Analysis

Volatility of earnings = Stdev (t )

Volatility of earnings = Stdev (t )

rit = α + βj rmt + ij

+ 2β6 GOit + β7 CSit + β8 AT Sit + t

+ 2β6 GOit + β7 CSit + β8 AT Sit + t