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Accruals, Investment, and the Accrual Anomaly

This paper investigates two competing hypotheses for the accrual anomaly: investment/growth and persistence. Both investment/growth and persistence information in accruals are likely to vary cross‐sectionally, depending on a firm's business model, a fact that generates different cross‐sectional implications for the accrual anomaly. I find that the magnitude of the accrual anomaly monotonically increases with the investment information contained in accruals, as measured by the co‐variation between accruals and employee growth. In industries/firms in which accruals co‐vary with employee growth, accruals show strong predictive power for future stock returns. In industries/firms in which accruals show little correlations with employee growth, the accrual anomaly is much weaker. In contrast, the evidence from the cross‐sectional analysis is inconsistent with the persistence argument. From the earnings perspective, the evidence on one‐year‐ahead earnings growth is inconclusive, but the results on longer‐term ea...