Accrual Quality, Realized Returns, and Expected Returns: The Importance of Controlling for Cash Flow Shocks

52 Pages Posted: 25 Nov 2008 Last revised: 10 Aug 2012

See all articles by Maria Ogneva

Maria Ogneva

University of Southern California - Marshall School of Business

Date Written: January 25, 2012

Abstract

This paper develops a simple methodology based on the earnings response coefficient framework that allows decomposing realized returns into cash flow shocks and returns excluding cash flow shocks. I find that stocks with poor (good) accrual quality were on average subject to relatively lower (higher) cash flow shocks over the past 37 years. These lower (higher) cash flow shocks offset the higher (lower) expected returns of poor (good) accrual quality firms. After excluding cash flow shocks, future realized returns are negatively associated with accrual quality. The premiums pertaining to accrual quality are both statistically and economically significant in standard asset-pricing tests when cash flow shocks are excluded by firm-specific return decomposition. Overall, this paper provides evidence on the existence of a priced accrual quality risk factor, and underscores the importance of controlling for cash flow shocks in asset-pricing tests that use realized returns.

Keywords: Accounting quality, asset pricing, cash flow shocks, cost of equity

JEL Classification: M41, M43, G12

Suggested Citation

Ogneva, Maria, Accrual Quality, Realized Returns, and Expected Returns: The Importance of Controlling for Cash Flow Shocks (January 25, 2012). Available at SSRN: https://ssrn.com/abstract=1306598 or http://dx.doi.org/10.2139/ssrn.1306598

Maria Ogneva (Contact Author)

University of Southern California - Marshall School of Business ( email )

701 Exposition Blvd
Los Angeles, CA 90089
United States

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