Managerial Discretion in Accruals and Informational Efficiency

In this paper we examine the relation between managerial discretion in accruals and informational efficiency. We measure managerial discretion in accruals by the absolute value of discretionary accruals. Assuming that efficient prices follow a random walk, we measure informational efficiency by using stock return variance ratios. We find that the absolute value of discretionary accruals is negatively associated with the price deviation from a random walk pattern, estimated in the 12-month period subsequent to the accrual reporting; hence, future informational efficiency increases with the extent to which managers exercise discretion over accruals. The results are consistent with the view that discretionary accruals, on average, convey useful information to investors and facilitate the price convergence to its fundamental value. Our findings are robust to a battery of tests, which we run to validate both our measures of informational efficiency and our measure of managerial discretion in accruals