Accruals Management, Investor Sophistication, and Equity Valuation: Evidence from 10–Q Filings

Steven Balsam · Eli Bartov · Carol A. Marquardt

336 citations0/0 files storedJournal of Accounting Research

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Auditing, Earnings Management, Governance Financial Markets and Investment Strategies Corporate Finance and Governance

Abstract

The release of the full set of financial statements in Form 10–Q provides investors with the data necessary to estimate the discretionary portion of earnings, thereby allowing them to better assess the integrity of reported quarterly earnings. We thus expect a negative association between unexpected discretionary accruals estimated using 10–Q disclosures and stock returns around 10–Q filing dates. Consistent with our expectations, we document a negative association between unexpected discretionary accruals and cumulative abnormal returns over a short window around the 10–Q filing date. Furthermore, this association varies systematically with investor sophistication. Finally, results from portfolio tests indicate that this association is economically as well as statistically significant. One interpretation of our findings is that accruals management has substantial valuation consequences, which are quickly impounded into stock prices.

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References

2012Detecting Earnings Management 1994Debt covenant violation and manipulation of accruals 1999Earnings Management to Exceed Thresholds 1998Earnings Management and the Long‐Run Market Performance of Initial Public Offerings 1996The pricing of discretionary accruals 1998Earnings management and the performance of seasoned equity offerings1I gratefully acknowledge the comments and suggestions of Philip Berger, Patricia Dechow, Kenneth Gaver (the referee), Robert Holthausen, Wayne Mikkelson (the editor), and Richard Sloan. I also thank Andrew Alford, Brad Barber, Randolph Beatty, Ilia Dichev, Paul Fisher, Gary Gorton, Paul Griffin, David Larcker, Mark Low, Patricia O'Brien, Madhav Rajan, Jay Ritter, Mark Vargus, Robert Verrecchia, Franco Wong, and workshop participants at the 1996 American Accounting Association meetings, Columbia University, Emory University, INSEAD, London Business School, MIT, New York University, Northwestern University, Purdue University, University of California at Davis, University of Chicago, University of Michigan, University of Minnesota, University of Pennsylvania, and Yale University for useful comments. I am indebted to Mark Vargus for access to his FORTRAN sub-routines. Errors and omissions are my responsibility.1 2000Investor Sophistication and Patterns in Stock Returns after Earnings Announcements

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2003Investor Sophistication and the Mispricing of Accruals 2004How Informed Are Actively Trading Institutional Investors? Evidence from Their Trading Behavior before a Break in a String of Consecutive Earnings Increases

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