Stock returns, earnings management, and discretionary accruals: An examination of the accrual anomaly

The purpose of this dissertation is to examine earnings management as it relates to the accrual anomaly. In this examination, three primary research questions arise. First, I address the question as to whether or not accrual decomposition models can, in actuality, be used to identify earnings management firms in the general population of firms. Second, I address the question as to whether or not earnings management firms drive the accrual anomaly. Third, I address the question as to whether or not the accrual anomaly results from a reversal of an overreaction to the earnings announcements of earnings management firms. With respect to the first question, although I am unable to conclude that extreme decile firms, in general, manage earnings, I find that the firms in the highest and lowest discretionary accrual deciles are more likely to contain firms with incentives to manage earnings upwards and downwards, respectively. Results relating to the second question are mixed. While regression analysis does not support the contention that earnings management firms drive the anomaly, hedge portfolio analysis reveals that earnings management firms produce significantly higher returns. With regards to the final question, although I find some evidence of positive abnormal returns accruing to high accrual firms and negative abnormal returns to low accrual firms around their announcement dates, the magnitudes of these returns are far too small to explain the long-run returns that have been documented. Additional contributions of this research include (1) evidence that the KLW Jones model is most effective at identifying earnings management firms when analyzing the general population of firms and (2) evidence that the abnormal returns of the accrual anomaly should be measured from firms' actual earnings announcement dates, rather than from four months following fiscal year-ends.