Two Accrual Anomalies: A Dichotomy of Accrual-Return Relations∗

Motivated by the findings that the aggregate (discretionary) accruals positively predicts oneyear-ahead firm-level stock returns and that there is a considerable amount of co-movement in firm-level (discretionary) accruals, we decompose firm-level (discretionary) accruals into a market-wide component and a firm-specific component. We document robust evidence that the two orthogonal (discretionary) accrual components affect stock returns in qualitatively opposite ways — while the firm-specific component negatively predicts next-period stock returns, firms with a higher level of market-wide component have on average higher next-period stock returns. Moreover, the two accrual-return relations co-exist and the accrual anomaly due to the firm-specific component of (discretionary) accruals largely supersedes the conventional accrual anomaly documented in Sloan (1996) and Xie (2001). Furthermore, a hedge strategy explicitly exploiting the two accrual anomalies yields a significantly higher return than that of a typical accrual strategy built only on firm-level (discretionary) accruals. Our analysis shows that accounting information such as (discretionary) accruals affects the stock market through both market-wide and firm-specific channels. We briefly discuss potential economic rationales behind each of the two accrual anomalies. JEL Classification: G1, G3, M4