Distress Risk Information in Accruals

Past accrual anomaly studies have documented results that suggest that distress risk increases systematically across decreasing accruals portfolios. I investigate and find a negative relation between accruals and distress risk, evidence that suggests that the accruals trading strategy of buying firms with low accruals and selling firms with high accruals results in exposure to higher distress risk. I show that distress risk is compensated by higher future returns. I then show that the future abnormal returns from the accruals trading strategy decline after controlling for distress risk. In addition, I find that the abnormal returns to the accruals trading strategy are largely driven by trading in firms within high distress risk portfolios. My evidence suggests that the accrual anomaly persists because of the lower abnormal returns and the need to trade in firms with high distress risk.