Workshop Series: David Emanuel
This paper examines what is known as the “accrual anomaly”, that is investors tend to overrate the persistence of the accrual component of earnings relative to the cash flow component, resulting in a negative association between current period accruals and future share returns. This anomalous finding extends to special items, which is the focus of this study. The setting is South Africa, where the separate disclosure of a number of transitory items has been mandatory since 2000. The main purpose of this study is to determine whether mispricing is observed in a regulatory setting where it is mandatory for these items to be disaggregated.
The evidence from our study shows that headline earnings (the recurring part of earnings) has higher persistence than headline earnings exclusions (the non-recurring part of earnings). Accruals are less persistent than cash flows, which can be attributed largely to headline earnings exclusions. Isolating those cash flows which form part of headline earnings exclusions improves the persistence parameter of cash flows. When both the Mishkin (1983) method and the OLS method suggested by Kraft et al. (2007) are used, our results show that investors significantly underweight the cash flow component of earnings. However, none of the other earnings components reflects significant mispricing. When additional explanatory variables are included in the analyses, the mispricing of the cash flow component disappears. This evidence may be useful in the International Accounting Standards Board’s and Financial Accounting Standards Board’s deliberations on whether to require a specific form of disaggregated disclosures.
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David Emanuel is the Ernst & Young Professor of Financial Accounting at the University of Auckland.
His major research interests are in empirical financial accounting, and corporate governance. He has published in international academic and New Zealand based professional journals, is the co-author of four books and is editor of a book of readings. Recent publications have been in Auditing: A Journal of Practice and Theory, Review of Quantitative Finance and Accounting, Journal of Banking and Finance, New Zealand Economic Papers, and International Journal of Case Studies in Management.
He is also a corporate finance consultant with Ernst & Young, where he advises on capital structure, financial valuations including “fair value” requirements in accounting standards including impairment testing, performance evaluation systems, and employee share ownership plans.
David is a Fellow and Life Member of the New Zealand Institute of Chartered Accountants. He is also a member of the Education Board of the Institute of Chartered Accountants in Australia.