Do Accruals Exacerbate Information Asymmetry in the Market?

A considerable body of evidence, both archival and experimental, suggests that accounting accruals are heterogeneously interpreted by investors. In this study, I examine whether the information asymmetry among investors arising from this heterogeneous interpretation, implied in these empirical results, affects transactions costs in the form of the bid-ask spread and its adverse selection component. I examine this impact both, in general, for all trading activity occurring for a firm over a continuous flow of information during the year and around the first release of accrual information for each quarter. The results of the study provide empirical evidence of a positive association between the adverse selection component of the bid-ask spread and accruals in the yearly analysis. The results of the quarterly event tests conducted both around earnings announcements and the 10-Q/10-K filing dates indicate that the increase in the adverse selection component of the spread is positively linked to the absolute magnitude of total accruals. Documenting the existence of such a real cost of accruals provides a transactions cost basis for understanding why cost of capital increases with accrual activity (Dechow et al. 1996, Francis et al. 2005) as well as suggesting that the information asymmetries associated with such activity merit serious attention of accounting policy makers