UiS Working Papers in Economics and Finance,
University of Stavanger

Abstract: For more than 40 years oil and gas companies have been able to choose between two competing methods for accounting for exploration activities. The literature suggests that accounting method discretion can potentially signal managements' private information with the benefit of improving the relevance of accruals for forecasting future cash flows. However, if accounting method flexibility is used for financial window-dressing, accruals can lose their value-relevance and investors will resort to cash flows measures instead. In this study we compare the value-relevance of earnings versus cash flow for oil and gas companies from 1992 to 2013. Our results suggest that earnings are not significant, independent of accounting method choice, consistent with the view that accruals have limited value in the oil and gas industry. Rather, it seems that cash flow measures of both current and future profitability are significantly associated with oil company returns. These findings suggest that the financial markets lack confidence in oil company earnings, irrespective of accounting method choice.

Keywords: Full cost versus successful efforts; oil and gas company valuation; petroleum accounting; value-relevance.

JEL-codes: G12; M40; Q33

44 pages, December 18, 2015

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