Aggregate Discretionary Accruals and Future Market Returns: International Evidence

We conduct a cross-country analysis to provide further insight into the “lean-against-the-wind” hypothesis of aggregate discretionary accruals (Kang et al. 2010), i.e., opportunistic use of discretionary accruals in times of market undervaluation. We investigate whether the reversal of firm-level effect extends to non-U.S. firms and identify institutional factors that affect the association between aggregate discretionary accruals and future market returns. We find that the association between aggregate discretionary accruals and future market returns is less positive in countries with stronger disclosure requirements and more in countries with greater financial analysts, suggesting that aggregate discretionary accruals contain less garbling component in stronger legal/regulation environments and more garbling component in countries where the market incentive to manipulate earnings is high. We also use a K-median clustering to classify the sample countries into two clusters using seven country-level institutional variables. The results suggest that countries that have institutional features that lead to earnings management have greater coefficients on aggregate discretionary accruals, while countries that have institutional characteristics that mitigate earnings management behavior have smaller coefficients on aggregate discretionary accruals. In sum, our results are broadly consistent with the “lean-against-the-wind” hypothesis and highlight the role of institutional and socio-economic factors in understanding the phenomenon.