Accruals' persistence, accruals mispricing and operating cycle: evidence from the US

Abstract

PurposeThe purpose of this paper is to investigate the effect of operating cycle on the differential persistence of accruals and cash flow, and the market reaction to the different components of earnings across firms with various operating cycles.Design/methodology/approachBy examining the US public firms' earnings and the capital market reaction to different components of earnings, from 1964 to 1993, it is found that the longer the operating cycle, the lesser will be the persistent of accruals.FindingsThis result is consistent with Sloan's theory that the differential persistence of accruals is attributable to estimation errors in accruals. Moreover, the market efficiency test shows that the mispricing of accruals is greater for firms with longer operating cycle, indicating that investors fixate on earnings, while ignoring the persistence of accruals among firms with different earnings quality.Originality/valueThis paper adds to the growing literature that has begun to examine the factors affecting accrual persistence and accrual mispricing by indicating that the length of operating cycle can play a role. In addition, it provides fresh evidence that the market fixates on earnings, thus emphasizing the importance of contextual analysis of financial statement. Finally, it corroborates Sloan and Xie that estimation errors in accruals drive the lower persistence of accruals.