The Informational Role and Value Relevance of Earnings, Cash Flows, and Accruals

43 Pages Posted: 29 Jun 2016 Last revised: 16 Sep 2016

See all articles by David J. Ashton

David J. Ashton

University of Bristol - Department of Economics

Pengguo Wang

Xfi, University of Exeter

Date Written: September 15, 2016

Abstract

In this paper, we establish a theoretical relationship between earnings components and future stock returns. It shows the informational role of earnings, cash flows and accruals in predicting future stock returns and the key role played by the earnings response coefficient. It also suggests that the ‘accrual anomaly’ can be explained rationally. Accounting fundamentals jointly determine the covariance risk between uncertain future cash flows and the discount factor: accruals are encompassed as long as there exists differential persistence between cash flows and accruals after controlling for aggregate earnings. In particular, it is the deviation of (scaled) accruals from their long run mean rate that is vital in explaining the ‘accrual anomaly’. Consequently, Sloan (1996) and similar results should not be interpreted as an accrual-based anomaly, instead they document important evidence of the possible fair pricing of accruals.

Keywords: Stock Returns, Earnings Components, the Ball-Brown Analysis, Accrual Anomaly

JEL Classification: M41, G12, G14

Suggested Citation

Ashton, David John and Wang, Pengguo, The Informational Role and Value Relevance of Earnings, Cash Flows, and Accruals (September 15, 2016). 27th Annual Conference on Financial Economics and Accounting Paper, Available at SSRN: https://ssrn.com/abstract=2801644 or http://dx.doi.org/10.2139/ssrn.2801644

David John Ashton

University of Bristol - Department of Economics ( email )

8 Woodland Road
Bristol BS8 ITN
United Kingdom
+44 (0)117 928 8423 (Phone)

Pengguo Wang (Contact Author)

Xfi, University of Exeter ( email )

Streatham Court
Exeter, EX4 4PU
United Kingdom

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