How Is Accruals Quality Priced by the Stock Market?

• In Event: Accounting Information and Future Stock Returns

Abstract

The relationship between accruals quality and the cost of equity is an important research question in recent literature. Francis et al. (2005) find that lower accruals quality is associated with higher stock returns. We show that this result is driven by a small number of the smallest firms. For the majority (80%) of the relatively large firms, the opposite relationship holds, consistent with the differences of opinion and short-sale constraints theory of Miller (1977) and many recent studies on information uncertainty. Moreover, accruals quality as a source of information risk affects the returns through liquidity risk. Once exposure to liquidity risk is controlled, the positive return difference between poor and good accruals quality firms in the smallest firm group disappears, and the negative return difference for the relatively large firms widens. Further tests based on short-sale constraints and earnings announcements support the Miller (1977) theory. Overall, we conclude that lower accruals quality is associated with lower returns for the majority of firms.

Authors

• Carl Brousseau, Universite Laval

• Zhaoyang Gu, University of Minnesota, Twin Cities Campus