The Impact of Interest Coverage Ratio on Value Relevance of Reported Earnings: Evidence from South Korea

Hyunmi Ji
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Hyunmi Ji: College of Business Administration, Keimyung University, Daegu 42601, Korea

Sustainability, 2019, vol. 11, issue 24, 1-11

Abstract: This study examined the usefulness of the cash-based interest coverage ratio (CICR). It also verified the usefulness of accrual-based interest coverage ratio (AICR), which is used as a criterion for exiting insolvent companies. This paper analyzed whether the value relevance of earnings to stock price differs according to various interest coverage ratios. The CICR is measured by dividing the cash generated from operations by the interest payments. AICR is measured by operating income divided by interest expenses. The research model for the hypothesis test of this study is based on the Ohlson model, which has been used for the test of stock value relevance in many previous studies. As a result of the empirical analysis, the CICR is used as useful information by the investors in the capital market. CICR is used as useful information in the capital market as an indicator of sustainability of profits. This study suggests that supervisors and financial institutions can make rational decision-making if they consider AICR and CICR as criteria for exiting insolvent companies. The contribution of this study was to suggest that the CICR can be a useful indicator for determining whether a company is insolvent due to its relatively low forecast error and high predictability.

Keywords: earnings sustainability; interest coverage ratio; earnings persistence; value relevance (search for similar items in EconPapers)
JEL-codes: O13 Q Q0 Q2 Q3 Q5 Q56 (search for similar items in EconPapers)
Date: 2019
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Persistent link: https://EconPapers.repec.org/RePEc:gam:jsusta:v:11:y:2019:i:24:p:7193-:d:298323

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