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Predicting Stock Market Returns with Aggregate Discretionary Accruals

Predicting Stock Market Returns with Aggregate Discretionary Accruals. Comments on. Authors: Qiang Kang, Qiao Liu, and Rong Qi (KLQ). Discussant: Wuchun Chi, National Chengchi University. KLU’s Methods & Findings.

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Predicting Stock Market Returns with Aggregate Discretionary Accruals

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  1. Predicting Stock Market Returns with Aggregate Discretionary Accruals Comments on Authors: Qiang Kang, Qiao Liu, and Rong Qi (KLQ) Discussant: Wuchun Chi, National Chengchi University

  2. KLU’s Methods & Findings • KLU regress current excess market return (Rt) on lag aggregate (and discretionary) accruals (Xt-1). • Aggregate accruals and their discretional component, proxies for market-wide earnings management, have the ability to forecast one-year-ahead stock return at the aggregate level (it’s different from Sloan and his followers, Sloan did this at the firm-level and portfolio-level)

  3. Value-weighted discretionary

  4. Several Issues

  5. Several Issues • Before performing the formal analysis, for me, it seems that KLQ do not clearly explain the relation among “aggregate accruals”, “firm-level accruals”, and “market inefficient”. • Especially, the results on aggregate accruals”, and “firm-level accruals” are completely diverse in this study.

  6. Why Market is Inefficiency:Evidence from the Firm-Level DAC Individual firm’sreturn ispredictable Investors do notunderstand theearnings persistencebehind accruals Firm-level abnormal accruals

  7. Why Market is Inefficiency:Evidence from the Aggregate Level DAC Aggregate stockmarket returns are predictable ? Aggregateabnormal accruals

  8. Three recent accounting studies (all are firm-level study) might be related to KLU • Kothari, S.P., A. Leone, and C. Wasley (2005, JAE). • Ball and Shivakumar (2006, JAR) • Richardson, Sloan, Soliman, and Tuna (2005, JAE)

  9. Kothari, Leone, and Wasley (2005, JAE). • Jones model and modified Jones model are mis-specified for firms with extreme financial performance (Dechow, Sloan and Sweeney 1995). • Kothari et al. (2005) demonstrate that performance-matched abnormal accruals capture earnings management better than do traditional Jones model-estimated abnormal accruals.

  10. Ball and Shivakumar (2006, JAR) • What is the role of accruals (increase or decrease earnings)? • They conclude that the role of accruals it to enhance earnings quality by conservative accounting (i.e., timelier loss recognition). • More negative accruals, ceteris paribus, mean more conservative from the point of view of managements. • More positive accruals, ceteris paribus, mean more optimistic about the future.

  11. Another Conjecture but Very Immature • Regression model: Rt= a + bDACt-1. • The market participants (instead of managers in KLU’s study) interpret the lag (time t-1) earnings information (at time t), and naively believe that lag accruals (the more positive accruals, the more optimistic) is positively associated with current year’s (time t) prospect.

  12. Richardson, Sloan, Soliman, and Tuna (2005, JAE) • Xie (2001) and KLU (2006) decompose accruals as non-discretionary and discretionary parts. • Richardson et al. (2005) further decompose accruals into (1) working capital, (2) non-current operating assets, and (3) financial assets.

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