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This study is primarily motivated by the increasing concern of the academic, practitioners, regulators and standard setters regarding the quality of earnings and financial reporting. The purpose is to investigate whether the accrual anomaly exists in Australia; whether the occurrence of the accrual anomaly is attributed to the discretionary accruals component stemming from managerial discretion; and the impact of corporate governance reforms on accrual mispricing.

This study employs the Mishkin (1983) rational expectations test to examine whether the earnings expectations embedded in stock prices accurately reflect the differential persistence of earnings components. It also employs the hedge portfolio trading strategy to examine whether taking a long position in firms with low accruals and a short position in firms with high accruals will yield positive abnormal stock returns.

The results show that investors overestimate the persistence of accruals and underestimate the persistence of cash flows and subsequently, overprice the accruals and underprice the cash flows. The evidence of accrual mispricing is severe for the component of discretionary accruals. Nonetheless, the association between discretionary accruals and abnormal returns are weakened during the corporate governance reforms period.

It should be cautious to attribute the investors' ability to accurately price accruals and cash flows to the passage of corporate governance reform program. Despite there is control for firm size, book-to-market, PE multiple, growth and leverage, other macro-economic factors such as interest rates, inflation and GDP could potentially have an impact on stock returns.

The passage of corporate governance reform program has increased the level of financial reporting disclosure and the monitoring of management, which subsequently improved accruals persistence and earnings quality. A direct practical implication is that investors should better understand the information in accruals for future earnings when the corporate disclosure environment is strengthened.

This study provides useful information to regulators, academics and investors interested in market efficiency and accrual mispricing. The results suggest that the reform of corporate governance is associated with more efficient prices. This may be of interest to the regulators who intend to improve earnings quality and financial reporting environment through the regulatory reform.

To test the accrual anomaly in the period of corporate governance reforms is particularly useful to regulators and policy makers. It allows regulators and policy makers to gain insight as whether the change of regulation has been effective – more transparent and timely reporting of financial information are supposed to help the investors to better understand the accruals and thus mitigate the potential for accrual mispricing.

The purpose of this paper is to investigate the effect of operating cycle on the differential persistence of accruals and cash flow, and the market reaction to the different components of earnings across firms with various operating cycles.

By examining the US public firms' earnings and the capital market reaction to different components of earnings, from 1964 to 1993, it is found that the longer the operating cycle, the lesser will be the persistent of accruals.

This result is consistent with Sloan's theory that the differential persistence of accruals is attributable to estimation errors in accruals. Moreover, the market efficiency test shows that the mispricing of accruals is greater for firms with longer operating cycle, indicating that investors fixate on earnings, while ignoring the persistence of accruals among firms with different earnings quality.

This paper adds to the growing literature that has begun to examine the factors affecting accrual persistence and accrual mispricing by indicating that the length of operating cycle can play a role. In addition, it provides fresh evidence that the market fixates on earnings, thus emphasizing the importance of contextual analysis of financial statement. Finally, it corroborates Sloan and Xie that estimation errors in accruals drive the lower persistence of accruals.

This paper aims to hunt for the driving force behind the accrual anomaly and revisit the risk versus mispricing debate.

In sorts of stock returns on abnormal and normal accruals, the authors find that abnormal accruals are the driving force behind the accrual anomaly. The authors then construct characteristic-balanced portfolios from dependent sorts of stock returns on the abnormal accrual characteristic and a related factor-mimicking portfolio to test whether the accrual anomaly is due to risk or mispricing (Daniel and Titman, 1997; Davis et al., 2000).

Similar to Hirshleifer et al. (2012), the authors find that the accrual anomaly is due to mispricing and that the measure of accruals used in Hirshleifer et al.’s study (2012) is a very broad measure of accruals. The authors therefore recommend the use of abnormal accruals in future research.

The results suggest that there are limits to arbitrage or behavioral biases with regard to the trading of low-accrual firms. Showing that the accrual effect is driven by the level of abnormal accruals, the findings of this study strongly challenge the rational risk explanation proposed by the extant literature.

The purpose of the study is to investigate the possible role of annual report readability in accrual anomaly, shedding light on why investors fail to incorporate accruals information in a timely and unbiased manner beyond the original naive investor fixation explanation.

Using five proxies of annual report readability and available data over 1993–2017, we investigate whether accrual overpricing is more severe when annual reports are less readable.

We find little (substantive) evidence of accrual overpricing among high (low) readability firms. The readability effects are contingent on the level of business complexity and earnings management.

This study extends the original naive investor fixation explanation and documents annual report complexity as a market friction in explaining the accrual anomaly, contributing to the mispricing vs risk debate and supporting the efficient market hypothesis.

Low readability of annual reports is a red flag to investors.

This study provides support for regulatory initiatives aimed at enhancing readability of corporate disclosures to address market frictions and improve market efficiency.

Accrual anomaly has posed a challenge to the efficient market hypothesis. This study draws on and adds to the line of research indicating that annual report complexity is a friction erecting a barrier to transparency, hindering market efficiency. This study contributes to our understanding of the enigmatic accrual anomaly.

This study examines the effect of stock liquidity on the magnitude of the accrual anomaly.

This paper examines the relation—both time-series and cross-sectional—between stock liquidity and the magnitude of the accrual anomaly and use the 2001 minimum tick size decimalization as a quasi-experiment to establish causality.

There is both cross-sectional and time-series evidence that stock liquidity is negatively related to the magnitude of the accrual anomaly. Moreover, the extent to which investors overestimate the persistence of accruals decreases with stock liquidity. Results from a difference-in-differences analysis conducted using the 2001 minimum tick size decimalization as a quasi-experiment suggest that the effect of stock liquidity on the accrual anomaly is causal. The findings of this study are consistent with the enhancing effect of stock liquidity on pricing efficiency.

The study's findings are well aligned with the mispricing-based explanation for the accrual anomaly, suggesting that the improvement in market-wide stock liquidity drives the contemporaneous decline in the magnitude of the accrual anomaly, at least to a great extent.

The purpose of this paper is to examine whether the stock market in India is efficient in the semi-strong form.

The study uses financial and stock market data of 1,135 listed Indian companies (non-financial) during 2003–2011 collected from Capital IQ to estimate discretionary accruals (DA) using modified Jones model (1995). The study also examines using the widely used Mishkin (1983) test to whether equity market prices accruals in India. The study is conducted for profit/loss-making firms separately as well as for a hedge portfolio of firms based on the lowest to highest accruals.

The empirical study of DA of 1,135 listed Indian companies (non-financial) during 2003–2011 shows that the estimated average DA of the corporate sector in India comes to 1 percent of the total assets of these firms. An empirical analysis whether equity market prices DA in India finds no evidence of investors/market pricing DA. Empirical evidence also finds that the results are invariant for profit/loss-making firms as well as portfolio of firms based on the lowest to highest accruals in the Indian context. The empirical evidence shows that the Indian equity market is inefficient with regard to the incorporation of accruals in expected returns of stocks.

This study builds on the previous literature on accrual pricing in the context of the USA and developed markets. The study extends the empirics to the one of the largest emerging market economy – India. This issue is important not only to investors, but also to policy makers and researchers because the mispricing of accruals could potentially lead to misallocation of capital. The study has implications for stock/firm valuations and cost of equity/capital.

This is the first study for the pricing of accruals and test of semi-strong efficiency of the Indian stock market.

The purpose of this paper is to investigate whether the special items (SI) mispricing reported in Burgstahler et al. is distinct from the accruals (ACC) mispricing documented in Sloan.

This paper employs the control hedge‐portfolio test, non‐overlap hedge‐portfolio test, and regression analysis to determine whether the SI anomaly is distinct from the ACC anomaly. In addition, the Mishkin test is used to examine the impact of SI on the ACC anomaly.

This paper has four main findings. First, one‐year‐ahead abnormal returns to the special‐items‐based hedge portfolio are much diminished when holding ACC constant, whereas those to the ACC‐based hedge portfolio remain significantly positive when holding SI constant. Second, the special‐items‐based hedge portfolio loses much of its ability to earn future abnormal returns without the help of extreme ACC, whereas the ACC‐based hedge portfolio remains profitable without the help of extreme SI. Third, SI are no longer negatively associated with future abnormal returns after controlling for ACC, whereas ACC remain negatively associated with future abnormal returns after controlling for SI. Finally, SI affect the extent to which the market overprices ACC, with negative (positive) SI aggravating (alleviating) ACC overpricing.

This is the first paper to show that the SI anomaly is dependent on the ACC anomaly.

The purpose of this paper is to revisit the question of whether analysts anticipate accruals’ predicted reversals (or persistence) of future earnings. Prior evidence documents that analysts who provide information to investors are over optimistic about firms with high working capital (WC) accruals. The authors propose that empirical models using WC accruals alone may be incomplete and hence not entirely appropriate to assess the level of analysts’ understanding of accruals. The authors argue that analysts’ optimism about WC accruals might not be due to their lack of sophistication, but rather driven by incomplete accrual information embedded in forecast accuracy tests.

The authors use non-financial US firms for the period between 1976 and 2013. The authors define earnings forecast errors as the analysts’ consensus earnings forecasts minus the actual earnings provided by IBES deflated by share price from CRSP. The authors carry out forecast error regressions on individual accrual components by decomposing total accruals into categories. The authors perform the tests across 12 months starting from the initial analysts’ forecasts, which are generally issued in the first month after the prior period earnings announcement date. The final sample contains 48,142 firm–year observations per month.

The empirical tests show no correlation between analysts’ forecast errors and revised total accruals. The findings are robust to different samples, periods, model specifications, decile ranked accruals, high accruals, absolute forecast errors, controlling for cash flows (CF) and high accounting conservatism. The findings imply that if analysts are to achieve more accurate forecasts, they should be considering all rather than some accrual components. The authors interpret this evidence as an indication of analysts’ relative sophistication with respect to accruals.

The authors recognise that analysts’ correct anticipation of accruals’ persistence does not mean that their earnings forecasts are entirely free of bias. Analysts can make forecast errors for various reasons including strategic biases. For instance, the tests show pessimistic forecast errors with respect to CF, which is in line with similar findings in prior research (Drake and Myers, 2011). Hence, the authors suggest that future research examine this correlation in greater depth as CF components are with the highest level of persistence, and hence should be predicted most accurately.

The results imply that the argument about analysts’ lack of sophistication with respect to accruals’ persistence is not warranted. The results imply that forecasts appear to contribute to market efficiency. Another implication is that analysts seem to utilise all relevant accrual information in their forecasts, hence traditional accrual definition should be revised in future studies. Key inferences of the paper imply that the growing use of analysts’ reports by institutional investors and money managers in their decision-making processes is justified despite the debate in the prior literature on the role and the reputation of analysts as surrogates of market expectations.

The research sheds a new light on the question whether sell-side security analysts are able to anticipate the persistence of accruals in future earnings.

This paper investigates the presence of the accrual and the cash flow anomalies in the New Zealand stock market for the period of 1987 to 2003. We observe insignificant evidence of the accrual anomaly but find strong evidence of the presence of the cash flow anomaly. However, from 1987 to 1992 – a period before the introduction of the Companies and the Financial Reporting Acts 1993 – the presence of the accrual anomaly was statistically significant suggesting that the introduction of the FRA had a significant impact on the occurrence of the anomaly. We observe further that firms with high discretionary accruals experience significant negative future stock returns. This evidence is consistent with the notion that managers of these firms engage in earnings management.

The purpose of this paper is to examine the informational content of retained and distributed earnings for future profitability and stock returns.

The paper utilizes firm‐level cross‐sectional persistent regressions, Mishkin's econometric framework and portfolio‐level analysis.

The paper shows that investors act as if the components of retained earnings (current operating accruals, non‐current operating accruals and retained cash flows) have similar implications for future profitability, leading to an overvaluation of their differential persistence. It also appears that while they cannot distinguish between the distinct properties of distributed earnings, they correctly anticipate the persistence of net cash distributions to debt holders (net debt repayment) but underestimate the persistence of net cash distributions to equity holders (dividends minus net stock issues). Overall, the findings of the paper suggest that the accrual anomaly documented in the accounting literature and the anomaly on net stock issues documented in the finance literature could be a subset of a larger anomaly on retained earnings.

The paper enhances one's understanding of the conflicting market's reaction to the accrual and cash flow component of earnings.