Why do accruals predict earnings?

Jonathan Lewellen and Robert J. Resutek

Journal of Accounting and Economics, 2019, vol. 67, issue 2, 336-356

Abstract: Higher accruals are associated with lower subsequent earnings. We show this phenomenon can be explained by the way sales, profits, and working capital respond to changes in a firm's product markets. Empirically, high accruals predict high subsequent sales growth but a long-lasting drop in both profits and profitability. Accruals also predict an increase in future competition, suggesting that accruals are correlated with abnormally high—and, in equilibrium, transitory—true profitability that attracts new entrants to the industry. Overall, the predictive power of accruals is better explained by product-market effects than by measurement error in accruals or diminishing returns from investment.

Keywords: Accruals; Earnings; Persistence; Measurement error; Reversals (search for similar items in EconPapers)
Date: 2019
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Citations: View citations in EconPapers (10)

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Persistent link: https://EconPapers.repec.org/RePEc:eee:jaecon:v:67:y:2019:i:2:p:336-356

DOI: 10.1016/j.jacceco.2018.12.003

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