Can Conservatism Affect the Accruals Anomaly?

• In Event: Financial Accounting and Reporting 2

Abstract

This paper investigates accounting conservatism’s effects on accrual persistence in predicting future earnings and, in turn, the accruals anomaly. We posit that conservatism’s asymmetric reliability and verifiability requirements for income increasing accruals will affect high accrual firms more than low accrual firms. As predicted, we find that greater conservatism increases accrual persistence more in high accrual decile (HAD) firms than in low accrual decile (LAD) firms. Similarly, conservatism’s effects on accruals in predicting future returns are higher for HAD firms relative to LAD firms. These results are supported at the firm and portfolio-level. The portfolio-level results show an approximate 21 percent greater annual abnormal accrual hedge return when portfolios are also partitioned by conservatism. Our results provide further evidence in explaining the accruals anomaly and that the markets do not capture accounting conservatism fully.

Authors

• Gulraze Wakil, Carleton University

• Pervaiz Alam, Kent State University