The Persistence of Accruals and Investment in Operating and Investment Cycle

Abstract

This paper investigates the relation between investment and accruals to disentangle earning-fixation hypothesis. We decompose total accruals into working capital accruals, long-term investment and non-transaction accruals to test whether the investment can explain the accruals anomalies and behavior in operating and investment cycle. We use the financial information of 135 firms listed on the Tehran Stock Exchange (TSE) from 2005 to 2011 through OLS approach and find that long-term investment and non-transaction accruals are able to predict subsequent net income and free cash flow. Whereas, working capital accruals do not have this ability. To predict subsequent ROA, the persistence of total accruals, Long-term investment and external financing decrease in longer operating cycle. Total accruals are more persistent and non-transaction accruals and external financing are less persistent in the longer investment cycle. Total accruals and external financing are inversely related to subsequent returns, implying that accruals anomalies as well as external financing anomalies exist in our sample. To predict future returns, the persistence of total accruals and working capital accruals decrease, however, the persistence of external financing and non-transaction accruals and long-term investment increase in longer operating cycle. Total accruals and non-transaction accruals are more persistent and working capital accruals and long-term investment are less persistent in longer investment cycle, but the persistence of external financing is not related to investment cycle.