Accruals, Investment, and the Accrual Anomaly

Posted: 5 Feb 2007 Last revised: 4 Nov 2007

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Abstract

This paper investigates two competing hypotheses for the accrual anomaly: investment/growth and persistence. Both investment/growth and persistence information in accruals are likely to vary cross-sectionally, depending on a firm's business model, a fact that generates different cross-sectional implications for the accrual anomaly. I find that the magnitude of the accrual anomaly monotonically increases with the investment information contained in accruals, as measured by the co-variation between accruals and employee growth. In industries/firms in which accruals co-vary with employee growth, accruals show strong predictive power for future stock returns. In industries/firms in which accruals show little correlations with employee growth, the accrual anomaly is much weaker. In contrast, the evidence from the cross-sectional analysis is inconsistent with the persistence argument. From the earnings perspective, the evidence on one-year-ahead earnings growth is inconclusive, but the results on longer-term earnings growth support the investment argument but not the persistence argument. Collectively, I conclude that these results support the view that the accrual anomaly is attributable to the fundamental investment information contained in accruals.

Keywords: Accruals, investment, persistence, accrual anomaly, earnings management

JEL Classification: G12, G14, M41

Suggested Citation

Zhang, Frank, Accruals, Investment, and the Accrual Anomaly. Accounting Review, Vol. 82, No. 5, pp. 1333-1364, October 2007. Available at SSRN: https://ssrn.com/abstract=960981

Frank Zhang (Contact Author)

Yale School of Management ( email )

135 Prospect Street
P.O. Box 208200
New Haven, CT 06520-8200
United States

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