Information Asymmetry and the Accrual Anomaly

• Published date: 01 August 2018
• Author: Boyoung Kim,Ingoo Han,Sang Hyun Park,Jaywon Lee
• Date: 01 August 2018
• DOI: http://doi.org/10.1111/ajfs.12225

Information Asymmetry and the Accrual

Anomaly*

Sang Hyun Park**

Hull College of Business, Augusta University, United States

Ingoo Han

KAIST College of Business, Korea Advanced Institute of Science and Technology, Republic of Korea

Jaywon Lee

College of Business Administration, Sejong University, Republic of Korea

Boyoung Kim

Department of International Industrial Information, Kyonggi University, Republic of Korea

Received 10 March 2017; Accepted 4 January 2018

Abstract

This study investigates the association between information asymmetry and the accrual

anomaly. Prior literature argues that earnings management is pronounced among firms with

high information asymmetry and that earnings management is the main phenomenon behind

the accrual anomaly. Using 43 205 firm-year observations from the CRSP/Compustat Merged

(CCM) universe spanning 1975–2012, we provide empirical evidence that the accrual anom-

aly is generally concentrated in firms with higher information asymmetry. Additional analysis

reveals that, investors’ greater overestimation mainly takes a place in firms with negative

accruals, rather than positive accruals, due to investors’ risk-aversion tendencies.

Keywords Accrual anomaly; Abnormal returns; Information asymmetry; Mishkin test; Persis-

tence of accruals

JEL Classification: G14, M41

*This paper is based on Sang Hyun Park’s PhD dissertation at KAIST College of Business.

**Corresponding author: Hull College of Business, Augusta University, 1120 15th Street,

Augusta, GA 30912, United States. Tel: +1-706-729-2172, Fax: +1-706-667-4587, email:

sapark@augusta.edu.

Asia-Pacific Journal of Financial Studies (2018) 47, 571–597 doi:10.1111/ajfs.12225

©2018 Korean Securities Association 571

1. Introduction

This paper examines the association between information asymmetry and the

accrual anomaly.

1

Prior literature suggests that investors are less able to detect earn-

ings management when information asymmetry is high and are unable to properly

assess and evaluate earnings management because of information asymmetry (Dye,

1988; Trueman and Titman, 1988; Schipper, 1989). Hence, in settings where infor-

mation asymmetry is high, managers may have more incentive to engage in earn-

ings management since the probability of investors detecting and properly

interpreting such actions is lower.

The extant literature also argues that earnings management is the main phe-

nomenon behind the accrual anomaly. Xie (2001) and Pincus et al. (2007) docu-

ment that the accrual anomaly is mostly attributable to the abnormal component of

total accruals. Managers’ discretion for accruals results not only in abnormal accru-

als (e.g., Dechow et al., 1995; Dechow and Schrand, 2004), but also in unreliable

and less persistent accruals (Richardson et al., 2005). Therefore, we hypothesize that

investors’ mispricing of accruals will be exacerbated by information asymmetry.

According to Sloan (1996), the accrual anomaly arises when investors naively

fixate on earnings and do not fully incorporate the differential persistence of accru-

als and the cash flow components of earnings. To better understand the accrual

anomaly, many researchers have proposed various explanations for the phe-

nomenon. Some argue that the accrual anomaly is a special case of a growth anom-

aly (Fairfield et al., 2003) while others offer risk-based explanations (Mashruwala

et al., 2006; Khan, 2008, 2012). Studies corroborating Sloan (1996) contend that

investors’ fixation on earnings accounts for the majority of the accrual anomaly

(e.g., Xie, 2001; Richardson et al., 2005; Pincus et al., 2007). By comparing various

explanations of the accrual anomaly, Shi and Zhang (2012) demonstrate that the

earnings fixation hypothesis (EFH hereafter) is the most relevant explanation.

We take a similar perspective, that investors’ fixation on earnings induces the

accrual anomaly and that the accrual anomaly will be exacerbated by higher levels

of information asymmetry. Using the Mishkin (1983) test, we document that the

accrual anomaly is generally concentrated among firms with high levels of informa-

tion asymmetry. In addition, the results indicate that investors are more likely to

overestimate the persistence of accruals in high information asymmetry portfolios

when the actual time-series property of persistence of accruals decreases as the level

of information asymmetry increases. This widens the gap between perceived and

actual persistence of accruals, and thus creates the abnormal return in the next per-

iod. Our results also reveal that, while this overestimation takes place mainly in the

1

The accrual anomaly arises when investors “fixate” on earnings, thereby not differentiating

the persistence of each component of earnings: accruals and the cash flow component. As a

result, firms with low (high) accruals experience positive (negative) abnormal stock returns

in the following period (Sloan, 1996).

S. H. Park et al.

572 ©2018 Korean Securities Association