Can Managers Use Discretionary Accruals to Ease Financial Constraints? Evidence from Discretionary Accruals Prior to Investment

Abstract:     
Despite a large literature on discretionary accruals, how the use of discretionary accruals impacts corporate financial decisions is not well understood. We hypothesize that a financially constrained firm with valuable projects can use discretionary accruals to credibly signal positive prospects, enabling it to raise capital to make the investments. We examine a large panel of firms during 1987 to 2009 and find that financially constrained firms with good investment opportunities have significantly higher discretionary accruals prior to investment compared to their unconstrained counterparts. Constrained high-accrual firms have higher earnings-announcement returns than constrained low-accrual firms, obtain more equity and debt financing, and invest in projects that appear to improve performance. These results provide supporting evidence that the use of discretionary accruals can help constrained firms with valuable projects ease those constraints and increase firm value.

Number of Pages in PDF File: 52

Keywords: Financial constraints, discretionary accruals, investment, signaling, valuation, external financing

JEL Classification: G31

working papers series