GB791 Unit 6 Seminar Reflection Example

An Anomaly That Faded: A Unit 6 Seminar Reflection on What Sloan's Accrual Study Showed

[Student Name]

Purdue University Global

GB791: Advanced Topics in Accounting

Unit 6 Seminar Reflection

[Instructor Name]

[Date]

The classmates are composite; the studies discussed are real.

Where I Started

My notes for the session held one sentence: "High-accrual firms earn lower future returns because investors fixate on total earnings, so accruals remain a mispricing signal." My source was Sloan (1996). In his data, the accrual part of earnings carried forward into next year's earnings less strongly than the cash part did, while share prices were set as though investors missed the gap. A portfolio that bought low-accrual firms and sold high-accrual firms earned substantial abnormal returns in the years that followed. I had used that finding in a work presentation to argue that our analysts should screen holdings on accrual levels, and I thought of it as settled.

The Challenge

My classmate Owen asked whether I knew what had happened to the returns since. I did not. He summarized Green et al. (2011), who documented that the hedge returns to the accrual strategy shrank toward zero in later years, to the point where the anomaly had largely disappeared from United States data after the early 2000s. If the mispricing were a durable feature of how investors process earnings, Owen asked, why had it vanished?

Three Explanations

The seminar spent most of the hour on that question, and three explanations emerged.

The first, which Green and colleagues themselves favored, was that capital flowed into the strategy once it was published. Hedge funds and quantitative managers began trading on accruals in the late 1990s, and their trading pushed prices toward the values the strategy predicted, removing the profit. On this reading, the anomaly was real, investors did misprice accruals, and arbitrage eventually corrected it.

The second explanation was about measurement. Hribar and Collins (2002) showed that accruals estimated from changes in balance sheet accounts, the method Sloan used, contain errors when firms make acquisitions, divest units or reclassify accounts, because those events change balance sheet balances without producing accruals in the ordinary sense. Accruals measured from the cash flow statement avoid many of those errors. A classmate argued that part of what looked like mispricing may have been measurement noise concentrated in particular kinds of firms.

The third explanation was that accruals stand in for something else. Fairfield et al. (2003) argued that accruals are one component of growth in net operating assets, and that the lower future profitability associated with high accruals is also found with other forms of growth, such as growth in long-term operating assets. If so, the accrual anomaly is really a growth anomaly, and investors may have been misjudging the returns to growth in general rather than misreading accruals in particular.

Each explanation accepted that Sloan's pattern was real in his data and disagreed only about what it was a pattern of.

Where My Position Moved

By the end of the session I could no longer defend my original sentence. The claim that accruals "remain" a mispricing signal was simply wrong for recent data. More importantly, the claim that investors "fixate" on earnings was one interpretation of the pattern, and the seminar had given me two others that the original study could not rule out.

I had treated a finding as if it were a mechanism. Sloan's study established a correlation between accruals and future returns in a particular period, along with evidence about the persistence of earnings components that made a mispricing story plausible. It did not establish that investors fixate, because it did not observe investors. It observed prices.

What I Now Think the Study Showed

Sloan's lasting contribution, I would now argue, was the persistence result: that the accrual and cash flow components of earnings differ in how well they predict future earnings. That result has held up across many later studies, and it is the part of the paper that is about accounting. The returns result showed that, in his sample period, prices did not fully reflect that difference. Whether that was because investors fixated, because the measures were noisy or because accruals proxied for growth is a question the original study could not answer and was not designed to.

I am also less confident about using published anomalies in practice. A pattern documented in historical data and then published becomes something that capital can trade on, which can change the pattern itself. My work presentation should have asked whether the strategy still paid, not only whether it once had.

Unfinished Business

Still unresolved for me is how a researcher should state a finding like Sloan's so that readers do not make the mistake I made. Owen suggested that every anomaly paper should separate what the data show from the mechanism proposed to explain them, and that seems right, but I notice that the mechanism is usually what makes a paper interesting enough to publish. I want to think further about whether the incentives of publication encourage exactly the overreading I committed.

References

Fairfield, P. M., Whisenant, J. S., & Yohn, T. L. (2003). Accrued earnings and growth: Implications for future profitability and market mispricing. The Accounting Review, 78(1), 353-371. https://doi.org/10.2308/accr.2003.78.1.353

Green, J., Hand, J. R. M., & Soliman, M. T. (2011). Going, going, gone? The apparent demise of the accruals anomaly. Management Science, 57(5), 797-816. https://doi.org/10.1287/mnsc.1110.1320

Hribar, P., & Collins, D. W. (2002). Errors in estimating accruals: Implications for empirical research. Journal of Accounting Research, 40(1), 105-134. https://doi.org/10.1111/1475-679X.00041

Sloan, R. G. (1996). Do stock prices fully reflect information in accruals and cash flows about future earnings? The Accounting Review, 71(3), 289-315.