The role of accruals as a signal in earnings and dividend announcements

Abstract

PurposeThe purpose of this paper is to examine whether managers deliberately use accruals to convey information regarding firm future profitability.Design/methodology/approachThe paper uses contemporaneous earnings and dividend increase announcements in New Zealand as the research setting. This setting reduces the possibility of opportunistic income smoothing by managers and, hence, increases the validity of the inference on the accrual signaling hypothesis. The paper employs a refined accrual model that controls the performance effects in estimating the part of accruals subject to managerial discretion.FindingsThe paper finds evidence consistent with managers using both accruals and changes in dividends to communicate private information regarding firm future profitability to the market. In particular, dividend‐increasing firms are observed to report positive accruals that are correlated with the positive market reaction to dividend increase announcements and future profitability. These findings are robust to performance, growth, and post‐earnings announcement drift effects.Originality/valueThis paper provides evidence that managers use accruals in conjunction with a corporate event to convey their private information regarding firm profitability. The results of the study are expected to shed more light on signaling aspects of accruals and to some degree alleviate the negative perception of managerial discretions over accruals vastly documented in the earnings management literature. This will hopefully add supporting evidence to the signaling hypothesis of accruals, which has so far received limited attention in the literature.