The Influence of Estimation Risk on the Pricing and Mispricing of Operating Cash Flows Relative to Accruals

This paper extends the mispricing literature by documenting that the market underprices operating cash flows (OCF) relative to accruals by not fully adjusting prices to reflect the risk inherent in estimating future payoffs, incremental to the mispricing that results from the market not fully adjusting prices to reflect less persistent accruals. We partition this estimation risk into the risk resulting from manipulated (i.e., noisy) accruals and the risk inherent in uncertain accruals. We find that intrinsic values are more closely related to OCF with both types of estimation risk are high. The market, however, prices OCF higher only when the estimation risk resulting from uncertain accruals are high, but not as high as implied by the intrinsic pricing regressions.