Scandinavian Working Papers in Economics

SIFR Research Report Series,
Institute for Financial Research

No 13: Accounting Anomalies and Information Uncertainty

Jennifer Francis , Ryan LaFond , Per Olsson () and Katherine Schipper
Additional contact information
Jennifer Francis: Duke University
Ryan LaFond: University of Wisconsin
Per Olsson: Fuqua School of Business, Postal: Duke University, Box 90120, Durham, NC 27708 USA
Katherine Schipper: Financial Accounting Standards Board

Abstract: We examine whether rational investor responses to information uncertainty explain properties of and returns to accounting-based trading anomalies. We proxy for information uncertainty with two measures of earnings quality: the standard deviation of the residuals from a Dechow and Dichev (2002) model relating accruals to cash flows, and the absolute value of performance-adjusted abnormal accruals from a modified Jones (1991) model. Over 1982-2001, we find that accounting-based trading anomalies (post-earnings announcement drift, value-glamour, and accruals strategies) are correlated with earnings quality. Specifically, extreme anomaly portfolios have poorer earnings quality than non-extreme portfolios, and within the extreme anomaly portfolios, poor earnings quality securities are more prevalent and earn larger abnormal returns than good earnings quality securities. Consistent with greater resolution of uncertainty for poor earnings quality securities, the abnormal returns to poor quality securities converge to the abnormal returns to good quality securities as the post-portfolio formation period lengthens. Taken as a whole, these results indicate that information uncertainty plays an important role in explaining accounting anomalies.

Keywords: Information; Cost of capital; Returns anomalies; Trading strategies

JEL-codes: D82; G14; M41

53 pages, June 15, 2003

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