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The Accrual Anomaly<br />What it is, empirical evidence, and future research<br />Troy Shu<br />
Presentation outline<br />“Accruals predict significant, excess future returns”<br />
Accruals are a measure of earnings quality.<br />Earnings = CFO + Accruals<br />Example of an accrual: account receivables...
“Earnings fixation” is the primary hypothesis for why there is an accrual anomaly.<br />Accruals = Earnings – CFO =<br />∆...
Excessive inventory example<br />Earnings<br />Accruals<br />
We read three different research papers on the accrual anomaly.<br />Sloan: annual accruals (1996)<br />Lundholm et al.: a...
Here’s how they measured the accrual anomaly’s excess returns:<br />Every period, get previous year’s accruals, sort into ...
Accruals predict future excess returns pretty well.<br />Sloan (1962-1991): 10.4% (hedged) size adjusted returns in the fi...
Despite data and time constraints, the results of our replication of Livnat’s quarterly accrual research appear to be reas...
Despite data and time constraints, the results of our replication of Livnat’s quarterly accrual research appear to be reas...
Despite data and time constraints, the results of our replication of Livnat’s quarterly accrual research appear to be reas...
Here is a summary for future accruals research<br />Make sure holding period, signal and returns calculations are correct<...
Appendix AReplicating Livnat’s quarterly accrual study<br />What we want to reproduce: Table 2 “Accruals and Subsequent Re...
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Troy Shu Accrual Presentation

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Troy Shu Accrual Presentation

  1. 1. The Accrual Anomaly<br />What it is, empirical evidence, and future research<br />Troy Shu<br />
  2. 2. Presentation outline<br />“Accruals predict significant, excess future returns”<br />
  3. 3. Accruals are a measure of earnings quality.<br />Earnings = CFO + Accruals<br />Example of an accrual: account receivables<br />We are looking for companies with low accruals, high quality earnings<br />Accrual anomaly: high accruals tend to predict lower excess returns, low accruals tend to predict higher excess returns<br />
  4. 4. “Earnings fixation” is the primary hypothesis for why there is an accrual anomaly.<br />Accruals = Earnings – CFO =<br />∆Non-cash Current Assets - ∆Non-Debt Current Liabilities + other adjustments for non-cash and non-operating transactions<br />Basis: accruals are mean reverting<br />Example: accounts receivable<br />Investors fixate on earnings and, in aggregate, fail to consider that extreme accruals tend to “reverse” future earnings<br />Example: excessive inventory<br />
  5. 5. Excessive inventory example<br />Earnings<br />Accruals<br />
  6. 6. We read three different research papers on the accrual anomaly.<br />Sloan: annual accruals (1996)<br />Lundholm et al.: annual percent accruals (2010)<br />Livnat et al.: quarterly accruals (2011)<br />Accrual Signal = (Earnings – CFO ) / Average Assets<br />Percent Accrual Signal = (Earnings – CFO ) / |Earnings|<br />
  7. 7. Here’s how they measured the accrual anomaly’s excess returns:<br />Every period, get previous year’s accruals, sort into deciles<br />Measure the (size adjusted) return of buying after the signal announcement and holding for a year<br />Repeat for next year<br />At very end, calculate buy and hold return averages for each of the deciles<br />
  8. 8. Accruals predict future excess returns pretty well.<br />Sloan (1962-1991): 10.4% (hedged) size adjusted returns in the first year<br />Lundholm (1989-2007): 11.7% (hedged) size adjusted returns in first year<br />Finds that Sloan’s traditional accrual only produces 6.5% (hedged) size adjusted returns for the same period<br />Livnat (1991 - 2004): 3.4% (hedged) size adjusted returns in first quarter, 9.9% over first year<br />“Do Stock Prices Fully Reflect Information in Accruals and Cash Flows about Future Earnings?”, Sloan, 1996<br />
  9. 9. Despite data and time constraints, the results of our replication of Livnat’s quarterly accrual research appear to be reasonable.<br />Pretty graph made with ggplot2 R library<br />
  10. 10. Despite data and time constraints, the results of our replication of Livnat’s quarterly accrual research appear to be reasonable.<br />“Quarterly Cash Flows and Accruals”, Livnat et al, 2011<br />
  11. 11. Despite data and time constraints, the results of our replication of Livnat’s quarterly accrual research appear to be reasonable.<br />Livnat uses the SEC filings date, whereas we used a 3 month delay<br />Livnat’s returns are size adjusted, ours aren’t<br />He uses non restated Compustat financials, provided by Charter Oak. We only have restated.<br />
  12. 12. Here is a summary for future accruals research<br />Make sure holding period, signal and returns calculations are correct<br />Data processing using SQL vs. R<br />Be careful of delistings, bankruptcies<br />Look at percent quarterly accruals<br />Is the accrual anomaly dying?<br />“Percent Accruals”, Lundholm et al., 2010<br />
  13. 13. Appendix AReplicating Livnat’s quarterly accrual study<br />What we want to reproduce: Table 2 “Accruals and Subsequent Returns” in Livnat’s paper<br />Data period<br />1991-2004<br />See page 9 of Livnat for sample reduction conditions: market cap, missing financials, etc.<br />Accrual signal<br />Accrual = <br />[ Earnings (CS Quarterly Item 8) – CFO (CS Qtr Item 108) ] / Average assets (CS Qtr Item 44) between current and last quarter <br />Livnat uses non-restated financials from Charter Oak’s database to eliminate hindsight bias<br />Holding period<br />Start: two days after SEC filing date for quarter t<br />Two days assumes that investors receive the filing the next day and after processing it, enter the position the 2nd day<br />Through: one day after preliminary earnings announcement for quarter t+iwhere i=1,2,3,4<br />If preliminary announcement date is missing, replaced by 90, 180, 270, and 360 (calendar) days after SEC filing<br />Livnat says SEC filing dates of the 10Q/K forms are provided by Compusta. CS Filing Dates Database? http://www.compustat.com/products.aspx?id=2147492874<br />[Preliminary] earnings announcement dates are apparently Compustat Data Item RDQE… can also get from IBES<br />Return adjustment<br />Excess return = raw return – return on corresponding French size-B/M portfolio for same period<br />See top of page 10 in Livnat for more details on size-value return adjustment<br />Delistings: if security is delisted before the end of a holding period, Livnat uses the CRSP delisting return if available, <br /> -100% if company is forced to delist by exchange or bankruptcy<br />Note: Livnat deletes top and bottom 0.5% extreme buy and hold returns… don’t do this?<br />Decile ranking<br />At the end of every calendar quarter (April 1, July 1, October 1, Jan 1), accruals released in the previous 3 months are ranked into deciles<br />After all accrual signals have been sorted into deciles, one can calculate aggregate return statistics (e.g. average return) for each of the deciles<br />

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