The Risk Management Role of Accounting Conservatism for Operating Cash Flows

Abstract

This study examines relations between accounting conservatism and the downside risk of operating cash flows (OCF) and finds both unconditional and conditional conservatism to be negatively associated with OCF downside risk measured by indicators of OCF falling below expectations, by OCF’s root lower partial moment and by OCF at risk, with several additional results. First, both unconditional and conditional conservatism enhance cash holdings and its upside potential, thus helping mitigate subsequent OCF downside risk. Second, both unconditional and conditional conservatism reduce the effects of customer bargaining power on OCF downside risk. Third, conditional conservatism increases hedge usage and unconditional conservatism substitutes for hedging in mitigating OCF downside risk. Finally, downside cash flow beta enhances unconditional and conditional conservatism and the mitigating effect of unconditional conservatism on OCF downside risk during economic downturns. These findings lend support to conservatism’s role as a risk management tool and are robust to alternative measures and various controls.