Kothari, S.P. Loutskina, Elena Nikolaev, Valeri (Tilburg University, Center for Economic Research)
Abstract
We show that the agency theory of overvalued equity (see Jensen, 2005) rather than investors' fixation on accruals explains the accrual anomaly, i.e., abnormal returns to an accrual trading strategy (see Sloan, 1996). Under the agency theory of overvalued equity, managers of overvalued firms are likely to manage their firms' accruals upwards to prolong the overvaluation. Thus, high-accrual portfolios are likely to be over-represented with over-valued firms. Overvaluation, however, cannot be sustained indefinitely and we expect price reversals for high accrual firms. In contrast, undervalued firms do not face incentives to report low accruals, so undervalued firms are not concentrated in low accrual decile portfolios. Therefore, across the accrual decile portfolios, we predict and find an asymmetric relation between accruals and both prior and subsequent returns. In addition, consistent with the predictions of the agency theory of overvalued equity, we find high, but not low, accrual firms' investment-financing decisions and insider trading activity are distorted, and analyst forecast optimism is concentrated among the high-accrual decile portfolios. Overall, return behavior, analyst optimism, investment-financing decisions, and insider trading activity are all consistent with the agency theory of overvalued equity, but do not support investor fixation on accruals.
Download Info
To download:
If you experience problems downloading a file, check if you have the
proper application to
view it first. Information about this may be contained
in the File-Format links below. In case of further problems read
the IDEAS help
page. Note that these files are not on the IDEAS
site. Please be patient as the files may be large.
Publisher Info
Paper provided by Tilburg University, Center for Economic Research in its series Discussion Paper with number
103.
References listed on IDEAS Please report citation or reference errors to , or , if you are the registered author of the cited work, log in to your RePEc Author Service profile, click on "citations" and make appropriate adjustments.:
Konan Chan & Louis K. C. Chan & Narasimhan Jegadeesh & Josef Lakonishok, 2006.
"Earnings Quality and Stock Returns,"
Journal of Business,
University of Chicago Press, vol. 79(3), pages 1041-1082, May.
[Downloadable!]
Loughran, Tim & Ritter, Jay R, 1995.
" The New Issues Puzzle,"
Journal of Finance,
American Finance Association, vol. 50(1), pages 23-51, March.
[Downloadable!] (restricted)
Degeorge, Francois & Patel, Jayendu & Zeckhauser, Richard, 1999.
"Earnings Management to Exceed Thresholds,"
Journal of Business,
University of Chicago Press, vol. 72(1), pages 1-33, January.
[Downloadable!] (restricted)
Other versions:
Shleifer, Andrei & Vishny, Robert W, 1997.
" The Limits of Arbitrage,"
Journal of Finance,
American Finance Association, vol. 52(1), pages 35-55, March.
[Downloadable!] (restricted)
Other versions:
Cited by: (explanations, Please report citation or reference errors to , or , if you are the registered author of the cited work, log in to your RePEc Author Service profile, click on "citations" and make appropriate adjustments.)
Jiao, T. & Mertens, G.M.H. & Roosenboom, P.G.J., 2007.
"Industry Valuation Driven Earnings Management,"
Research Paper
ERS-2007-069-F&A Revision, Erasmus Research Institute of Management (ERIM), ERIM is the joint research institute of the Rotterdam School of Management, Erasmus University and the Erasmus School of Economics (ESE) at Erasmus Uni.
[Downloadable!]