The Impact of Cash Flow Volatility on Systematic Risk

In a word, where information is costly, volatile cash flows create information acquisition costs that reduce value. Thus, managers act to reduce their firm's volatility of cash flow in anticipation of higher value for shareholders. However, when managers reduce the firm's cash flow volatility, they also affect the systematic risk of their firm's stock. The direction of the relationship between cash flow volatility and systematic risk depends on the relative value of the firm's growth opportunities in relation to the firm's assets-in-place. We use a panel sample of 542 observations from United States insurance firms to investigate the relationship between cash flow volatility and systematic risk. The direction of the relationship between cash flow volatility and systematic risk has implications both for the education and for the practice of risk management. We make recommendations for risk management programs. Our findings also have implications for clienteles among the firm's stockholders. While the theoretical relationship between cash flow volatility and systematic risk can be generally applied, we only test this relationship for a sample of insurance firms