The Pricing of Accruals for Profit and Loss Firms

Abstract

In this paper we investigate whether the accrual anomaly exists for profit and for loss firms. The study was motivated by the findings of Hayn (1995) that, because of a liquidation option, losses would be less informative about a firm's future prospects. Joos and Plesko (2005) build on Hayn's results and by examining the components of earnings for categories of loss firms, they provide evidence suggesting that for transitory loss firms, investors identify negative accruals as being transitory and therefore not value-relevant. We provide evidence that the persistence of accruals is significantly greater for profit firms than for loss firms and that the accruals mispricing anomaly documented in Sloan (1996) is restricted mostly to profit making firms. We also report results that indicate that the differential pricing of accruals across profit and loss firms is driven by loss firms with negative accruals. We further disaggregate loss firms with negative accruals and find that the differential mispricing of accruals across profit and loss firms is attributable to the pricing of accruals for sub-samples of transitory and persistent loss firms (based on our definitions of these sub-samples). The accruals for profit firms are overpriced, while accruals for transitory loss firms are not mispriced and accruals for persistent loss firms are underpriced. Hence, the pricing of accruals for transitory loss firms is also different than the pricing of accruals for persistent loss firms and the pricing of accruals for both these sub-samples is different than the pricing of accruals for profit firms.