Article | Journal of Accounting, Auditing & Finance | April 2012

The Predictive Value of Accruals and Consequences for Market Anomalies

by Francois Brochet, Seunghan Nam and Joshua Ronen

Abstract

We revisit the role of the cash and accrual components of accounting earnings in predicting future cash flows using out-of-sample predictions and market value of equity as a proxy for all future cash flows. We find that, on average, accruals improve upon current cash flow from operations in predicting future cash flows. In the cross-section, accruals' contribution is positively associated with proxies for quality of accruals and governance. Next, we investigate the implications of accruals' predictive value for accrual-based market anomalies. We find that portfolios formed on stock return predictions using information from current CFO and accruals yield significantly positive returns on average, as opposed to CFO alone. We also find that Sloan's (1996) accrual anomaly is related to our accrual contribution anomaly. Indeed, when accruals' contribution to future cash flow prediction is the highest, the accrual anomaly vanishes. Collectively, our results suggest that the predictive value of accruals and market participants' ability to process it are a significant driver of accrual-based anomalies.

Keywords: Forecasting and Prediction; Investment Return; Value; Equity; Markets; Cash Flow; Information Management; Accrual Accounting; Earnings Management; Corporate Governance; Stocks;

Citation:

Brochet, Francois, Seunghan Nam, and Joshua Ronen. "The Predictive Value of Accruals and Consequences for Market Anomalies." Journal of Accounting, Auditing & Finance 27, no. 2 (April 2012).