Earnings Quality and Financial Reporting Credibility: An Empirical Investigation

July 01, 1999
  • Contributors:

    Mark T. Bradshaw, Scott A. Richardson, Richard G. Sloan
  • Topic:

    Other Research

Working paper

Firms with extremely high accruals experience subsequent reductions in earnings and are more likely to be subject to SEC enforcement actions for GAAP violations. In this paper, we show that analysts do not anticipate the earnings reductions in their earnings forecasts, and auditors do not signal the GAAP violations through their audit opinions.

Previous research has demonstrated that stock prices act ‘as if’ investors do not anticipate negative future consequences associated with high accruals. Our findings reinforce this interpretation by demonstrating that even professional investment intermediaries do not communicate the negative information associated with high accruals to investors.

Our results add to the growing body of evidence pointing to the conclusion that accrual accounting leads to temporary resource misallocation. That is not to say that other systems, such as cash accounting, would result in better resource allocation. It does, however, undermine the role of the efficient market hypothesis, on which academics have relied to gloss over many of the features of the accrual accounting system that seem to preoccupy managers and investors.



  • AQR Capital Management, LLC, (“AQR”) provide links to third-party websites only as a convenience, and the inclusion of such links does not imply any endorsement, approval, investigation, verification or monitoring by us of any content or information contained within or accessible from the linked sites. If you choose to visit the linked sites, you do so at your own risk, and you will be subject to such sites' terms of use and privacy policies, over which AQR.com has no control. In no event will AQR be responsible for any information or content within the linked sites or your use of the linked sites.

  • The information contained herein is only as current as of the date indicated, and may be superseded by subsequent market events or for other reasons. The views and opinions expressed herein are those of the author and do not necessarily reflect the views of AQR Capital Management, LLC, its affiliates or its employees.

    This information is not intended to, and does not relate specifically to any investment strategy or product that AQR offers. It is being provided merely to provide a framework to assist in the implementation of an investor’s own analysis and an investor’s own view on the topic discussed herein. Past performance is not a guarantee of future results.

  • Certain publications may have been written prior to the author being an employee of AQR.