Distressed firms and the secular deterioration in usefulness of accounting information

We investigate the relative and incremental usefulness of earning, cash flows, accruals and book values of financially distressed firms to extend our understanding of the price–earnings relationships of distressed firms. As expected, we find that earnings usefulness deteriorates with the onset of distress. We document that the decline in usefulness of earnings is initially gradual and then steep. We also document a surprisingly comparable decline in the usefulness of operating cash flows. Further, we find that accruals continue to provide incrementally useful information beyond cash flows up to 1 year prior to the bankruptcy or liquidation election. Our results hold even when the effects of book values and solvency measures are controlled.