Testing Additional Predictions of the Accrual Anomaly for Current and Future Returns

Prior papers report a negative association between current-period accruals and future returns (a.k.a. the accrual anomaly). The authors typically assume that investors naively treat accruals and cash flows the same when earnings are reported, and then the investors lose money in the subsequent year because accruals are less persistent than cash flows. We develop and test additional predictions from the naive investor hypothesis. In contrast to the predictions based on investor naivete, we find investors place more weight on accruals than cash flows in the current period. Also, future trading losses documented in prior research are only partially explained by accruals; cash flows explain as much or more of the anomalous returns. Our findings are more consistent with an under reaction to cash flows rather than an overreaction to accruals. Additional analyses fail to demonstrate a strong association between reliability of accruals and the market associations with accruals. Overall, we find support for the hypothesis that accruals capture information that is important to market participants but little or no support for prior conclusions that accruals are costly. The results contradict policy recommendations to curtail accruals. (This is a password protected paper, at the speaker's request. Please email">mailto:SoASeminar@smu.edu.sg">email us for the password).