The Pricing of Accruals Quality: January versus the Rest of the Year

Abstract

As an alternative way to shed light on the debate over whether accruals quality is a priced risk factor, we examine the effect of seasonality on the pricing of the modified Dechow and Dichev (2002) accruals quality measure (AQ). We find that (1) high AQ stocks outperform low AQ stocks only in January; (2) during the rest of the calendar year, high AQ firms underperform low AQ firms such that there is no AQ premium on an annual basis; (3) about half of the January AQ premium occurs during the first five trading days of January; (4) a January AQ premium is observed in almost every year of our sample period; and (5) the January AQ premium reflects, at least partly, the stock price effects of tax loss selling around the turn of the year. Taken together, these findings are difficult to reconcile with a risk interpretation of accruals quality.A fundamental issue in this debate is whether there is a robust, positive relation between AQ and future returns. 1 If high AQ firms do not outperform low AQ firms on average, then AQ cannot represent risk and additional asset-pricing tests, as in CGV, are moot. However, prior evidence on the relation between AQ and future returns is inconclusive, differing across studies, sample periods, and methodologies. For example, CGV conclude that there is no robust positive relation between AQ and future returns after controlling for market microstructure biases and/or transaction costs. On the other hand, Ogneva (2008) and Kim and Qi (2010) argue that high AQ firms do outperform low AQ firms after controlling for cash flow shocks or removing low-priced stocks, respectively.Since traditional asset-pricing tests (as in the above studies) have yielded mixed results on AQ's pricing, and thereby on the risk debate, we take a different approach and examine how seasonality affects AQ's pricing. In particular, we investigate the role of January versus the rest of the calendar year. As we show, viewing the pricing of AQ through a different lens-that of seasonality-is a powerful way of shedding light on whether AQ reflects risk. The seasonality approach also helps to explain why prior evidence on AQ's pricing (based on tests using all calendar-year months) has so far been ambiguous.Our exploration of January's role in AQ's pricing is motivated by two considerations. First, the nature of the AQ measure strongly suggests that it could proxy for tax loss selling around the turn of the year. If so, then January is likely to play an important role in AQ's pricing because tax loss selling causes (at least partly) the well-known January effect in stock prices (Roll 1983b;Reinganum 1983;Sias and Starks 1997;Poterba and Weisbenner 2001). 2 Prior research argues that firms with high operating or return volatility-such as small firms-are more likely candidates for tax loss selling because they are statistically more likely to experience operating losses, and therefore negative stock returns, in any given year (e.g., Roll 1983b; Constantinides 1984). This reasoning suggests that AQ could also proxy for tax los...

Earnings Quality Measures and Excess Returns

“…For example, mispricing can result from behavioral biases of investors, such as different investor degrees of sophistication (Bartov et al, 2000) and limited attention (Hirshleifer et al, 2011). Mispricing can be due to costs of acquiring information (Landsman et al, 2011), transaction costs and limits to arbitrage (Ng et al, 2008;Zhang et al, 2013), divergence of opinions (Garfinkel and Sokobin, 2006) or time of the year (Mashruwala and Mashruwala, 2011). However, Penman and Zhu (2011) find that excess returns can be consistent with rational pricing if earnings and revisions in earnings growth expectations are considered appropriately.…”

“…This literature typically uses a hedge returns approach, which is based on signed excess returns. Several papers, for example, Aboody et al (2005), Mashruwala and Mashruwala (2011), Shi and Zhang (2011), Ogneva (2012) and Brousseau and Gu (2012), study trading strategies based on accruals measures of earnings quality. Other papers, such as Francis et al (2005), Core et al (2008), examine abnormal trading profitability by investigating whether earnings quality is a priced risk factor.…”

The June Phenomenon and the Changing Month of the Year Effect

“…Hulbert (2008) and Ziemba (2010) show that the January effect is disappearing, He & He (2011) question whether the January effect is replaced by November effect. Easterday et al, (2009) report that the January effect does not occur in some years, while Ciccone (2011), Dzhabarov & Ziemba (2010), Mashruwala & Mashruwala (2011), Ziemba (2011 and Sikes (2014) argue that the January effect still appears in modern U.S. stock markets, particularly for small stocks. Mashruwala and Mashruwala (2011) show that stocks of high accruals quality (AQ) outperform low AQ stocks only in January.…”

Portfolio Quality and Mutual Fund Performance

“…Chan et al (2006) and Fama and French (2006) also determine a negative relation between accruals and returns. Recently, analysis of the accruals anomaly has focused on further deconstruction of its components (Zhang 2007) and the relationship between disclosure quality and mispricing (Drake et al, 2009;Mashruwala and Mashruwala 2011). However, Kraft et al (2006) document that once delisting returns are accounted for, the positive returns to low accrual portfolios disappear.…”