The Value of Long-Term Accrual Management

Abstract

Extant literature suggests that income smoothing can be measured either by the correlation between cash flows and accruals or by the volatility of accruals. We find that high levels of future returns associated with the correlation measure are completely offset by the negative future returns associated with accrual volatility over one-month to five-year horizons; that is, long-term accrual management leads to lower future firm values. This evidence holds for both discretionary and operating accruals, for firms that exhibit varying combinations of cash flowaccrual correlations and accrual volatilities, and after controlling for commonly used returninformative variables. Our analyses suggest that the net negative effect of income smoothing is attributable to information uncertainty due to accrual volatility.

Keywords: value, earnings smoothing, accrual volatility, future returns

JEL Classification: G12, M41