Earnings Quality and Short Sellers

• DOI: 10.2308/acch.2003.17.s-1.49
• Publication Date: 2008-03-28T23:42:16Z
• Authors: Scott Richardson
• Keywords: Earnings quality

SYNOPSIS: A key measure of earnings quality is the deviation net income from operating cash flows. Sloan (1996) finds that firms with high accruals (or a large gap between and flow) experience decline in performance not anticipated by investors, resulting predictable future returns. In this paper, I examine whether investors short sell securities accruals. Such strategy able to directly profit lower Using sample U.S. traded 1990-1 998, do find evidence sellers trade on basis information contained Keywords: accruals; quality; returns; sellers. Data Availability: are available sources identified text. INTRODUCTION Earnings often defined terms persistence sustainability. Revsine et al. (1999, 224-225) state considered be when they sustainable. Bodie (2002,628) speak extent which we might expect reported level sustained. more persistent viewed as higher quality. Examples low-quality include insufficient allowance for doubtful accounts, provisions obsolete inventory, aggressive revenue recognition practices bring revenues into current period. Common these examples low fact temporarily inflated due accounting choices, but flows unaffected. The levels does have direct result management activity. nature accrual accrue defer past, current, receipts disbursements. process involves significant amount estimation payments, subjective allocation past payments. doing so, creates accounts varying reliability. For example, recording realizable value receivables default risk across portfolio debtors. Other estimating recoverable amounts inventories, depreciating amortizing long-lived assets, post-retirement benefit obligations. Estimation errors various asset, liability, associated expense (either intentional or unintentional) will all lead earnings. Collectively, estimations ma nifest themselves magnitude documents greater than (i.e., accruals) following year. addition, stock prices fail impound implications earnings, leading return patterns Furthermore, reporting likely subject SEC enforcement actions (Dechow 1996; Bradshaw 2001) restatements (Richardson, Tuna, Wu 2002). suggests good indicator identify embedded Short particularly strong incentives utilize measures because can high-accrual firms. Previous research an informed subset who over-priced (see e.g., Figlewski 1981; Dechow et. 2001; Desai ability financial incentive information. …