Reconciling Growth and Persistence as Explanations for Accrual Mispricing

42 Pages Posted: 8 Apr 2008 Last revised: 14 Apr 2009

Paul Hribar

University of Iowa - Henry B. Tippie College of Business

Nir Yehuda

University of Texas at Dallas - Department of Accounting & Information Management

Date Written: March 1, 2008

Abstract

This paper examines the circumstances under which a growth explanation or a persistence explanation is a more likely explanation for accrual mispricing and whether accruals or cash from operations is a better measure of the mispricing. We hypothesize that mispricing of growth and a fixation on earnings are both descriptive of the accrual mispricing, but that they affect prices differently depending on where the firm is in its life cycle. We also hypothesize that the mispricing will have a stronger association with accruals or cash flows depending on which explanation drives the mispricing. Our results show that the orthogonal information in accruals is more related to growth characteristics, while the orthogonal information in cash flows is related to earnings persistence. Furthermore, in the growth stage, information in accruals is mispriced to a greater extent than the information in cash flows. Collectively, our results suggest that the investment-based explanation for accrual mispricing dominates in the growth stage and is best measured using accruals (and not operating cash flows). In contrast, the persistence explanation for accrual mispricing is more descriptively valid at maturity and decline, and the information contained in operating cash flows subsumes the information contained in accruals regarding earnings persistence.

Keywords: Accruals, Cash flows, Life cycle, Accrual anomaly

JEL Classification: G12, G14, M41, E32

Suggested Citation

Hribar, Paul and Yehuda, Nir, Reconciling Growth and Persistence as Explanations for Accrual Mispricing (March 1, 2008). Johnson School Research Paper Series No. #11-09. Available at SSRN: https://ssrn.com/abstract=1117739 or http://dx.doi.org/10.2139/ssrn.1117739

Paul Hribar

University of Iowa - Henry B. Tippie College of Business ( email )

Dept. of Accounting
Iowa City, IA 52242-1000
United States
319-335-1008 (Phone)

Nir Yehuda (Contact Author)

University of Texas at Dallas - Department of Accounting & Information Management ( email )

2601 North Floyd Road
Richardson, TX 75083-0688
United States

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