The Market Pricing of Accruals Quality

Source: Francis, J., LaFond, R., Olsson, P. & Schipper, K. (2005). *Journal of Accounting and

Economics* 39(2), 295–327.

TL;DR

Shows that accruals quality — how well a firm's accruals map into cash flows (the Dechow-Dichev

measure) — is priced: firms with poorer accruals quality face a higher cost of both debt and

equity. Poor accruals quality is treated by markets as information risk that investors require

compensation to bear.

That earnings quality is not just an accounting curiosity but a priced risk: low-quality (noisy,

hard-to-interpret) accruals raise a firm's cost of capital.

Compute accruals quality (AQ) as the standard deviation of the residuals from regressing

working-capital accruals on past, current, and future cash flows (Dechow-Dichev).

Relate AQ to costs of debt (interest rates, ratings) and equity (factor-model loadings, implied

cost of capital), and form an AQ factor.

Worse accruals quality → higher cost of debt and equity.

Returns load on an AQ factor, and the loading carries a premium — consistent with AQ as priced

information risk; the authors distinguish "innate" (business-driven) from "discretionary" AQ.

Operationalizes earnings quality as a priced factor, bridging accounting and asset pricing and

underpinning the quality-investing literature (alongside profitability/RMW).

Whether AQ is a genuine priced risk factor or a mispricing/characteristic is contested (Core,

Guay & Verdi 2008 challenge the pricing result).

The AQ measure mixes manipulation with innocent estimation noise.

Francis, J., LaFond, R., Olsson, P. & Schipper, K. (2005) — The Market Pricing of Accruals Quality — Journal of Accounting and Economics

Dechow, P. & Dichev, I. (2002) — The Quality of Accruals and Earnings — The Accounting Review

Core, J., Guay, W. & Verdi, R. (2008) — Is Accruals Quality a Priced Risk Factor? — Journal of Accounting and Economics