"The Market Pricing of Accruals Quality"

Paper Summary:

This paper analyzes the theoretical and methodological strengths and weaknesses of the research paper, "The Market Pricing Of Accruals Quality" by Jennifer Francis, Ryan LaFond, Per Olsson, Katherine Schipper. The paper summarizes the strengths of the research and underlines the weaknesses of the empirical method. Finally, this paper discusses the limitations of the theoretical approach.

Table of Contents:
Synthesis Of Strengths
Accruals Quality Has An Impact On The Information Risk And The Cost Of Capital
Innate Accruals Quality Has A Larger Impact Than Discretionary Accruals Quality Has
Methodological Weaknesses
The Specific Sample Cannot Be Applied Generally
Hypotheses And Methods Are Questionable
There Are Variances Between Empirical Findings And Other Results
Theoretical Limitations
Only The Systematic Component Of Earning Quality Risk Contributes To The Equity Risk Premium
The Relation Between Accruals Quality And Cost Of Capital Depends On The Fundamental Risk
Accruals Quality Is Neither A Priced Risk Factor Nor A Determinant Of The Cost Of Capital

From the Paper:

"In the paper Earnings quality and the equity risk premium: a benchmark model, Yee makes a distinction between the fundamental earnings and the reported earnings: the fundamental earnings are the accounting profits generating future dividend cash flows, while the reported earnings are the imperfect signal of fundamental earnings. He also makes the difference between the two sources of associated earnings risk: the fundamental risk and the earnings quality risk. The fundamental risk is the uncertainty of future dividends payments, whereas the earnings quality risk or information risk is the uncertainty that the reported earnings may not be announced quickly and precisely. Only the systematic components of earnings risk contribute to the equity risk premium, while all the components, either systematic or diversifiable, affect the earnings capitalization factors."

Sample of Sources Used:

• Linda H. Chen, Dan S. Dhaliwal, Mark A. Trombley The Effect of Fundamental Risk on the Market Pricing of Accruals Quality
• K. K Yee Earnings quality and the equity risk premium: A benchmark model
• Jennifer Francis, Ryan LaFond, Per Olsson, Katherine Schipper The Market Pricing of Earnings Quality
• John E. Core, Wayne R. Guay, Rodrigo S. Verdi Is Accruals Quality a Priced Risk Factor?
• Finn Scholler The quality of accruals and earnings - and the market pricing of earnings quality

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