The Study of Relationship between Operating Cash Flows, Earnings Opacity and Stock Price Crash Risk

Studies have shown that earnings opacity leads to crash risks –i.e. the severe price drops in subsequent periods. If managers manipulate earnings to hold bad news for a time period, such bad news will be gradually stockpiled. After a certain tipping point, it will become very expensive and even impossible for managers to continuously withhold bad news. Thus, stockpiled bad news comes out all at once and stock prices crash. Since operating cash flows is an important profit indicator and is likely to be less susceptible to manipulation, investigate whether operating cash flow can mitigate the adverse effect of earnings opacity in firm valuation. We used both ex ante and ex post measures of operating cash flow informativeness such as the extremity of operating cash flow-to-price ratio and cash flow variability to investigate the role of OCF in predicting crash risk. This study tests these relationship between operating cash flow , earnings opacity and stock price crash risk for 90 firms of listed on the Tehran Stock Exchange during 1386-1390. (Iranian Calander) It was found operating cash flow is a source of information useful to mitigate stock price crash risk. as operating cash flow informativeness increases, stock price crash risk generally decreases. Also results imply that operating cash flow is valued by the market and is useful in mitigating the relationship between earnings opacity and future crash risk. Namely can mitigate the adverse effects from opaque earnings, implying the operating Cash flow information may be under-used by the market.