Does the Accrual Anomaly End When Abnormal Accruals Reverse?

Abstract:     
The accrual anomaly is the negative relationship between extreme accruals and future stock returns. The fixation hypothesis states that this anomaly is due to mispricing caused by investor fixation on reported earnings without considering the reversing nature of accruals. The hypothesis implies that the market correction of the mispricing takes place when accruals reverse in the future, and that there should be no evidence of mispricing beyond the reversal point. We perform the most direct test of the fixation hypothesis by detecting not only the initiation but also the reversal of extreme abnormal accruals. For both extreme positive and negative abnormal accruals firms, we find a significant association between the reversal quarter's returns and initiated accruals, but no association between returns after the accruals reversal and initiated accruals. Thus, the mispricing ends when the accruals reversal is complete. We also find that analysts do not completely anticipate the reversal of accruals. Overall, our evidence supports the fixation hypothesis as an explanation for the accrual anomaly.

Keywords: abnormal accruals, accrual reversal, accrual anomaly, fixation hypothesis

Working Paper Series