Evidence of the Abnormal Accrual Anomaly Incremental to Operating Cash Flows

The purpose of our paper is to determine the extent to which operating cash flows may subsume the relation between future returns and various estimates of abnormal accruals. We are motivated by recent research which provides evidence that, after controlling for the operating cash flows-to-price ratio, accruals no longer relate to future returns. If accruals relate to future returns in a univariate model but not in a multivariate model that includes operating cash flows, then it must be the portion of accruals related to operating cash flows that drives the relation between accruals and future returns. If we label the portion of accruals that relates to operating cash flows as normal, then it is normal accruals, rather than abnormal accruals, that lead to evidence of an accrual anomaly. This supports the conclusion that the accrual anomaly is part of the overall value-glamour anomaly. We examine this issue in detail by testing the relation between future returns and residuals from various accrual expectation models (i.e., abnormal accruals). We employ several accrual expectation models, including those that specifically consider operating cash flows in the estimation. Moreover, we apply different accrual measures, including total and working capital accruals, and various estimation procedures, including industry-specific and firm-specific regressions. We find that for most of our accrual expectation models, abnormal accruals relate to future returns after controlling for the operating cash flow to-price ratio. We also document that the operating cash flows-to-price ratio is incremental to abnormal accruals in explaining future returns.