Portfolio Risk and Performance

Accruals and Future Performance: Can It Be Attributed to Risk?

Topics - Portfolio Risk and Performance Equities ESG Investing

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Accruals and Future Performance: Can It Be Attributed to Risk?

Research shows that firms with high accruals are more likely to post disappointing results. This “accrual anomaly” is well known. But not all accruals are alike.

Others have shown that, under the assumption of rational manager behavior and time-varying expected returns, any observed negative relation between investment activity (e.g., measures of accruals) and future firm performance is attributable to risk. The authors agree that this assertion has merit.

In this paper, the authors seek to differentiate among different kinds of accruals to determine whether some have a greater impact than others. They begin by categorizing firms into economically related groups based on common industry membership and shared industry-level supply chains. Then they divide various accrual measures into “firm specific” and “common” components.

They report that they are unable to document a reliably negative relation between observed investment activity and stock returns along the “common” dimension. However, they report finding a “very strong” negative relation for the “firm-specific” component. They conclude that the negative relation between accruals and future firm performance is primarily attributable to the firm-specific component and that risk alone cannot be a complete explanation for the accrual anomaly.

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Review of Accounting Studies

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