Can the earnings fixation hypothesis explain the accrual anomaly?

This paper provides further empirical evidence on whether the earnings fixation hypothesis can explain the accrual anomaly originally documented in Sloan (1996). The earnings fixation hypothesis suggests that the accrual anomaly is due to investors' fixation on reported earnings. We argue that, if investors fixate on reported earnings, future returns are related to not only accruals but also the responsiveness of the stock price to earnings, which leads to the empirical prediction that the returns to the accrual strategy are positively correlated with the stock price's responsiveness to earnings. Our empirical evidence confirms this prediction and thus lends support to the earnings fixation hypothesis. Our results are robust to alternative measures of accruals, alternative measures of the stock market's responsiveness to earnings and additional controls for measures of idiosyncratic volatility and transaction costs.