Implications of Firms Having Both Highly Negative Accruals and Cash Flows for Test of Accruals Anomaly

• In Event: Financial Accounting and Reporting IV

Abstract

This study reconciles the findings in recent studies regarding the weak accruals anomaly and the robust cash flows anomaly. We attribute the contrasting results to the firms having both highly negative accruals and cash flow. They dampen the accruals anomaly as they exhibit highly negative future stock returns although their accruals level is the lowest while reinforcing the cash flows anomaly. Investors seem to be negatively surprised by both the insufficient reversal of negative accruals and the high persistence of negative cash flows of these firms. The delisting effect (Beaver et al. 2007) cannot fully account for our results. Moreover, as future delisting cannot be anticipated ex-ante, one can partially exclude the delisting effect and implement more profitable accruals-based trading strategy by removing these firms. We also show that the prior finding that the accruals anomaly does not exist for loss firms (Dopuch et al. 2010) is also attributable to the firms having both highly negative accruals and cash flows. We document that after these firms are dropped, accruals-based hedge returns from loss firms are even larger than from profit firms.

Authors

• Jung Hoon Kim, Florida International University

• Young Jun Kim, Seoul National University