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Do Stock Prices Fully Reflect Information in Accruals and Cash Flows About…

- - - - Several studies have investigated the association of cash flows and accruals with security returns
      - There studies finds that both cash flow and accruals components of earning have incremental information content beyond earnings
  - - - Investor tend to fixate on reported earnings
      - Investor fixated on earning fail to impound other information properly
      - Not only earnings but also earnings components are useful in predicting future earning
        
        If market fails to impound this information it may respond surprisingly as if it is predictable changes
    - - But security market not fully consider the differences
    - - Investor failure to fully impound the information contained in earnings per se about future earnings
      - Investor failure to fully impound the information contained in the accrual and cash flow components of earnings about future earning.
    - - The persistence of current earning performance is decreasing in the magnitude of the accrual component of earning and increasing in the magnitude of cash flow component of earning
    - - The earning expectations embedded in stock prices fail to reflect fully the higher earnings persistence attributable to the cash flow component of earnings and the lower earning persistence attributable to the accrual component of earning
    - - The abnormal stock return predicted in H2 are clustered around future earnings announcement dates
  - - - CRSP file provide data on NYSE and AMEX firm from 1926
      - Finally consecutive data availability constrain for regression equation reduce the sample to 40,679 observation
    - - Size is well documented predictor
      - Time series regression
- - - - Benefit of using the "companion portfolio" approach is that it controls for the well known firm size effect
      - Study use 45th day after quarter end as the first day that the accrual and cash flow component of earning are known to investors because interim report are required to be filed within 45 day after fiscal quarter
      - Abnormal returns for other portfolios are not significant
      - The equally weighted average daily return for each portfolio is then constructed using all the firms each portfolio
    - - Provide evidence on the stability of the abnormal returns to the trading strategy
  - - - Measuring accruals
        
        Accrual decile portfolios are formed by ranking firms on the magnitude of the accruals component of earning
        
        Firm years are ranked quarterly and assigned in equal numbers to ten portfolio
        
        Deferred tax assume to be zero cause constantly missing
        
        Variable that chosed are scale by total assets at the start of the quarter to enable cross-sectional and cross-time comparison of data
        
        Define as the change in current assets other than cash and temporary investment less the change in current liabilities other than current portion on long term debt
      - Provides parameter estimates for equation which does not constrain the persistence coefficency
    - - Alternatively if security prices act as if investor do not distinguish between these 2 component of earning then the coefficients on that 2
  - - - This assumption is relaxed and the persistence of each component in predicting future quarterly earning is investigate
      - Assumes that the coefficients of accrual and cash flows are equally weighted
    - - These findings indicate that the market underweight the last period seasonally different quarterly earnings when capitalizing
      - The persistence of earning and the accrual and cash flow components of earning in predicting next quarter's earning is investigated
  - - - Mean persistence seasonally differences quarterly earnings is 0.303
      - The median industry persistence is similar to that of the pooled regression coefficient
      - Industry regression are conducted at the two digit industry classification level
      - Panel A Regression using actual values
      - Panel B Regressions using decile ranking
  - - - Although less appealing a priori it is still useful to investigate the abnormal return for portfolio formed on cash flows
      - Contrary to the results for accruals there is a positive relation between the cash flow portfolio ranking and abnormal returns
      - Consistent with prior studies there is a negative relation between the accrual portfolio ranking and abnormal return for both group
      - These finding might appear to be inconsistent with sloan
  - - - Reports the portfolio mean and median values
    - - Raise the possibility that a sort on accruals may be very similar
    - - Provides statistical on 2 potential risk factor