Accrual anomaly : balance sheet vs. cash flow statement measurement of accruals

Abstract

I explore the recent evidence on persistence of accrual anomaly, previously explored by Richard G. Sloan in 1996. Sloan (1996) highlights that the presence of cash flows statement data could improve the results to study accrual anomaly. Therefore, my motivation of the research is to explore accrual anomaly based on cash flows statement (CFS) method and balance sheet (BS) method for measuring accruals. The accounting academics report accruals as many different interpretations (such as the prospective growth of businesses and idiosyncratic risk) therefore, it may not be exploited under accruals hedge strategy. The data is inclusive of NYSE, AmEx, and NASDAQ listed firms, thereby to capture the complete US market from timeline 1990 to 2014. The analysis is based on Feltham & Ohson (1995) earnings persistence model and Mishkin (1983) test model for the market efficiency. I have found that earnings & earnings components are persistent in anticipating future earnings. I have also found that the market is inefficient in learning the persistence of earnings & its components. The market underestimates earnings persistence, overestimates persistence of accruals, and underestimates the persistence of cash flows. BS method and CFS method show the similar behavior of earnings and its components persistence and the market interpretation to them. However, CFS method measures the high persistence of cash flows. Moreover, accruals hedge returns are significant under BS method but insignificant under CFS method. Therefore, I conclude that accrual anomaly exists under BS method and disappears under CFS method. The market misinterpretation of earnings & its components persistence may not be associated with accruals anomaly.