The paper "The market pricing of accruals quality" sustains that the quality of accruals is priced by the financial markets. We can judge the value of this research by wondering to what extent, from a methodological and theoretical point of view, the accrual quality has an impact on the opportunity cost on capital. In the first place, we will summarize the strengths of the research paper; this point will allow us to come to underline the weaknesses of the empirical method in a second section; eventually, we will notice the limitations of the theoretical approach. According to the authors, accruals quality has an impact on the information risk and subsequently on the cost of capital: the poorer the accruals quality is, the greater the cost on debt and equity is. Nevertheless, innate accruals quality has a larger impact on the cost of capital than discretionary accruals quality has. Unlike cash accounting, in which transactions are registered only when flows are paid or received, accrual accounting respects the matching principle and economic events are recognised when transactions occur and not when payment is made.
[...] Only the systematic components of earnings risk contribute to the equity risk premium, while all the components, either systematic or diversifiable, affect the earnings capitalization factors / The relation between accruals quality and cost of capital depends on the fundamental risk In the paper The effect of fundamental risk on the market pricing of accruals quality, the authors corroborate and quantify the relation, while testing the theoretical model of Yee. The effect of accruals quality on the cost of capital increases with the fundamental risk. [...]
[...] The measure of accruals quality is explained by eight proxies in The quality of accruals and earnings and the market pricing of earnings quality: -the longer the operating cycle, -the smaller the firm -the greater the magnitude of sales volatility -the greater the magnitude of cash flows volatility ( the lower accruals quality -the greater the magnitude of accruals volatility -the greater the magnitude of earnings volatility -the greater the frequency of reporting negative net earnings -the greater the magnitude of accruals These results have been already announced by the authors in a former paper The market pricing of earnings quality. [...]
[...] As a result, the average positive coefficient on the accruals quality factor does not imply that the accruals quality factor is a priced risk factor but on average, firms have a positive contemporaneous exposure to the accruals quality factor mimicking strategy” / There are variances between empirical findings and other results 2.3 .1/ The empirical results are different from Sloan's results: Differences between Sloan's tests and tests of the authors are due to the following points: - First, Sloan's interest lies in the regression intercept, a measure of the unexpected return (alpha). [...]
[...] Under the method the coefficient estimates on accruals quality are larger when Z is excluded than when it is included as an independent variable; so, the pricing effect of discretionary accruals quality is biased upward .3/ Critique of Time-Series Regressions: In the paper Is Accruals Quality a Priced Risk Factor?, it is explained that time-series regressions of stocks returns on factors returns do not test the hypothesis that accruals quality is a priced risk factor. The total current accruals are defined as the sum weighted by average total assets of prior, current and future cash flows plus the change in revenue and PPE. [...]
[...] In spite of this very rigorous methodology, we can notice some weaknesses in the rationale / The specific sample cannot be applied generally 2.1 .1/ Geographical specificities: The authors require that each firm-year observation has data on accruals quality and the necessary market measures. Only firms with positive earnings during the year and five positive earnings in the industry during the year are selected. Furthermore, because the standard deviation is based on the five annual residuals, the sample considered in this study is restricted to firms with at least 7 years of data. [...]
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