The accrual anomaly in emerging markets : A thesis submitted in partial fulfilment of the requirements for the Degree of Doctor of Philosophy at Lincoln University

Abstract

During the past four decades, there has been extensive evidence of abnormal stock returns patterns related to particular equity trading strategies that cannot be explained or predicted by contemporary risk-based asset pricing models. The accrual anomaly is one of those abnormal stock patterns and poses a direct challenge to the Efficient Market Hypothesis. This phenomenon is referred to as the mispricing of accrual and cash flow components of earnings. In the presence of accruals mispricing, scholars find evidence of an abnormally positive hedge return from an accrual-based trading strategy which shorts on high-accruals and longs on low-accruals in the United States market. After two decades since its first introduction, the anomaly has been detected in other developed markets. Most studies in this field focus on the presence of the accrual anomaly in developed markets that have sufficient, reliable data with similar features to the United States market. No prior study of the topic concentrates on emerging markets in the international context. Although the accrual anomaly has been extensively studied, there are still limitations and a lack of understanding regarding some aspects of the phenomenon. Multivariate analyses based on accrual estimates are likely to subject to serious measurement error in accruals, causing misclassification when constructing accrual-based portfolios. Studies on estimation errors of accruals and accrual components suggest that the information content of accruals using different approaches may differ. The test of market efficiency in accrual pricing in previous studies has some limitations that can contaminate the analysis outcomes. Thus, further investigation is required to provide a better understanding of a robust approach to the accrual anomaly, especially in fast-growing emerging stock markets across the globe. This study investigates the presence and the drivers of the accrual anomaly using a sample of 12,708 firms in 20 emerging stock markets from 2000-2016. The empirical results show that cash flows are more attributable to earnings persistence than accruals, but both of these earnings components are mispriced in certain emerging markets. The study shows evidence of the accrual anomaly in nine emerging markets: Brazil, China, India, Indonesia, Malaysia, Peru, South Korea, Taiwan, Thailand, and a pooled sample of Arabian markets (Qatar, Saudi Arabia, and the United Arab Emirates). Abnormally high hedge returns of an accrual-based trading strategy are found in Chinese and South Korean stock markets. Further analysis indicates that the mispricing of accruals and cash flows in emerging markets is the mutual product of investor naivety and managerial incentives. Insider trading incentives and contracting incentives are potential motives for the aggressive use of accrual accounting. Therefore, corporate managers deliberately contribute to information asymmetry that drives the overvaluation of their stock.