Accruals, Growth, and Future Firm Performance

Abstract

The current debate in the literature about the role of accruals and growth in explaining earnings persistence and future returns is inconclusive. The problem stems from accrual and growth proxies being positively correlated, and neither convincingly subsuming the other in empirical tests. This study identifies a subset of firms for which accruals do not capture growth, thus providing a discriminating test. Specifically, I focus on firms with negative operating cycles and non-cash net working capital balances. These firms typically have declining net working capital as they grow because their business models result in current liabilities increasing faster than current assets. In this setting, high growth firms tend to have negative accruals. Contrary to the growth hypothesis, high growth firms with low accruals experience high future profitability and returns. These findings indicate that accounting distortions embedded in accruals have distinct implications for future performance.