Information and Accruals Strategy: When Does the Market Mis-price Accruals? *

This paper hypothesizes that more active informed trading and intense information production help investors detect the low persistence of accruals, and consequently reduce the magnitude of accruals mis-pricing. Applying both the Mishkin (1983) and the hedge-portfolio tests to subsamples sorted on the basis of a two-way classification – accruals and one of the information production measures, we find evidence showing that accruals mis-pricing is more conspicuous for stocks with high bid-ask spread, high analysts’ forecast error, and low presence of sophisticated institutional investors. Accruals trading strategies restricted to those informationally “opaque” stocks can yield annualized four-factor adjusted abnormal returns (the Fama-French three factors and the momentum factor) ranging from 14% to 23%. We also find that the market does not overreact to normal accruals for firms where information production is intense and effective.