The Investigation of Relationship between Accrual Quality and Expected Returns with Controlling for Future Cash Flow Shocks

Francis, LaFond, Olsson, and Schipper [6 and 7], document that accrual quality is inversely related to the cost of equity. However, Core, Guay, and Verdi [3] find no association between accrual quality and future stock returns and conclude that there is no evidence that the stock market prices accrual quality. With recourse to Ogneva [9] arguments, we hypothesize that Core et al.’s result arises because poor accrual quality firms experience negative cash flow shocks in the future, which results in negative returns that offset the higher expected returns for such firms. But Similar to Core et al. [3] and previous dissertations in Iran, after studying of 185 firm data between 1999 to 2008 we also find no significant association between expected returns and accrual quality after controlling for cash flow shocks. Overall, this paper adds to the growing literature suggesting that accrual quality is linked to the cost of capital.