The Risk Management Role of Accounting Conservatism for Operating Cash Flows

Abstract

This study examines whether unconditional and conditional accounting conservatism (UC and CC) serve risk management roles with respect to the downside properties of operating cash flows (OCF), and channels by which they operate. Our results reveal both UC and CC to be negatively associated with OCF downside risk measured by indicators of OCF falling below its expectations, OCF relative lower partial moments and OCF at risk. Tests of operative channels indicate that (1) UC and CC relate positively to cash holdings that reduce OCF downside risk and that (2) UC (CC) substitutes for (complements) corporate hedging in helping mitigate OCF downside risk. Further tests indicate that downside cash flow beta enhances the mitigating effects of UC and CC on OCF downside risk. These findings are robust to alternative measures and controls and lend support to accounting conservatism playing a risk management role with respect to OCF downside risk.