Xie (2001)

Reference

The Mispricing of Abnormal Accruals^a

Hong Xie

The Accounting Review, Volume 76, Issue 3 (July, 2001), 356-373.

Synopsis

This paper provides a small improvement to the trading strategy in Sloan (1996). The paper basically demonstrates the results documented in Sloan are driven by abnormal accruals. Abnormal are accruals are derived by orthogonalizing Sloan's original measure of accruals with respect to sales growth. This procedure removes 'normal' accruals that are driven by growth in operating activity. The remaining abnormal accruals are more likely to reflect transitory accounting distortions. Accordingly, the paper shows that the lower earnings persistence and the returns to the accrual trading strategy are driven by abnormal accruals. However, since most of the variation in accruals is assigned to abnormal accruals, the returns to the trading strategy based on abnormal accruals are of about the same magnitude as the returns using Sloan's original accrual trading strategy.