The Effect of Cash based Interest Coverage Ratio on the Value Relevance of Accounting Information

This study empirically verified the effect of cash based interest coverage ratio on the value relevance of accounting information. The accrual based interest coverage ratio, which divides operating profit by interest expense, includes accruals. On the other hand, the cash based interest coverage ratio, which is the cash inflow from the actual business divided by the actual outflow of interest, can be a better useful financial ratio indicator because the manager s discretionary accruals are removed. Investors in the capital market will be assessed as cash-strapped companies that fail to cover their interest payments with the cash generated by the business if the cash based interest coverage ratio is less than 1. In this case, we expect negative stock price reactions to the company s net profit and net asset book value. In this study, 2,991 companies that satisfy sample selection criterion of KOSPI and KOSDAQ listed companies from 2011 to 2014, to which International Financial Reporting Standards are obliged, were tested. The empirical results show that the value relevance of net asset value and earnings per share is lower when the cash based interest coverage ratio is less than 1. In other words, it is verified empirically that the cash based interest coverage ratio are useful financial ratios to judge the relationship between accounting information and stock price.