Discretionary Accruals: Credible Signals or Chinese Whispers?

Abstract

Unusually high accounting accruals are observable to sophisticated investors, who must then decide whether the accruals represent managerial manipulation of reported earnings or an indication of future firm performance. We hypothesise that both cash and stock dividends contain information useful to investors in making this distinction. We use China as our empirical setting, where both cash and stock dividends are common, and where the information environment is relatively weak. We find several interesting results which support out hypotheses: (i) cash dividends are associated with lower levels of abnormal accruals; (ii) when a cash dividend is paid, abnormal accruals are positively associated with current earnings and are predictive of future earnings; (iii) stock dividends are positively associated with abnormal accruals and with future earnings; and (iv) when stock dividends are paid, the market attaches a positive value to abnormal accruals. We also predict and find that it is firms with higher earnings per share growth which are more likely to distribute a stock dividend.