Inter-temporal Accrual Persistence and Accrual Anomaly

Prior accounting research argues that diminishing marginal returns on new investments drive lower persistence of accruals relative to cash flows. Macroeconomic research documents that marginal profitability is counter-cyclical, which implies that diminishing marginal returns on new investments are more pronounced during periods of expansions than recessions. Linking the cyclicality of diminishing returns on investments with the argument that diminishing returns to investments contribute to lower persistence of accruals relative to cash flows, this paper predicts that the differential persistence of accruals is greater during expansionary periods than recessionary periods. Using a U.S. sample from 1972 to 2003, I find that the differential persistence of accruals is greater during economic expansions than recessions. When I focus on the components of accruals, I find that depreciation, change in accounts receivable, change in raw materials, and change in finished goods are the main drivers of cyclical differential accrual persistence. These findings are robust to alternative conditioning sets, estimation procedures, and measures of the business cycle. I also find that investors are unable to assess the cyclical differential persistence of accruals, leading to higher returns (both raw and abnormal returns) from an accrual-based trading strategy during expansionary periods.