What drives the accrual spread? Evidence from a contemporary decomposition approach

• Main Authors: Cao, Viet Nga, Chaub, Frankie, Paudyal, Krishna
• Other Authors: Hội thảo quốc tế Ngân hàng và Tài chính thế giới 2015
• Format: Conference or Workshop Item
• Language: English
• Published: Trường Đại học Kinh tế 2020
• Subjects: Accrual decomposition; Earnings management; Financial constraint; Q-theory
• Online Access: http://repository.vnu.edu.vn/handle/VNU_123/97704
• Institution: Vietnam National University, Hanoi

We examine the main drivers of the accrual spread and the profitability of accrual-based trading strategies by disaggregating total accrual into three components: investment in working capital that supports growth, accrual estimation error, and temporary working capital fluctuation. Several findings emerge. First, stock returns are inversely related to working capital investment that supports growth and accrual estimation error, particularly in firms with higher long-term growth or are exposed to a higher degree of financial constraints. Second, investment in working capital drives the accrual spread through risk, whereas accrual estimation error does so through mispricing. The positive relationship between temporary working capital fluctuation and stock returns is also risk-based, implying that timing the input market may amplify firms’ exposure to the cyclicality of the product market. Finally, an implementable trading strategy based on a modified version of accrual estimation error can generate superior risk-adjusted returns to investors.