Persistence of Cash Flows in Firms Suspected of Manipulation

Abstract

Firms that are flagged as possible income manipulators have less persistent income, accruals, and cash flows when compared with non-flagged firms. The accruals persistence for flagged firms returns to the same level of accruals persistence for non-flagged firms after one year; however, cash flow persistence for flagged firms remains low for at least two years into the future, and average cash from operations remains lower for flagged firms at least 5 years into the future. In the year the firm is flagged the market estimates the persistence of cash flows at a level that roughly reflects their actual persistence but in the year after the firm is flagged the market underestimates the persistence of cash flows for those flagged firms. Overall, the market appears to slowly recognize the poor cash-generating potential of flagged firms.

Keywords: income manipulation, persistence, abnormal returns

JEL Classification: G14