The aim of this study is to examine why firms may manipulate not just their earnings but also their cash flows, and to investigate the effects of this behaviour on the cost of debt. The study highlights the discretion afforded in IFRS and US GAAP with regard to the reporting of operating cash flow. Using samples of firms in the UK and the USA, the results show that, for the ten years to 2010, the cost of debt has a significantly positive association with the managed (abnormal) component of operating cash flow. The market is more likely to incorporate abnormal operating cash flow information into pricing when firms are experiencing financial problems, especially when such companies are faced with low cash flows.

Keywords