Do Managers Credibly Use Accruals to Signal Private Information? Evidence from the Pricing of Discretionary Accruals Around Stock Splits

Abstract

Prior studies suggest that managers use their reporting discretion to signal their private information. Because managers are often assumed to use their discretion to mislead investors, we conjecture that, without a second corroborating signal, discretionary accruals are likely to be regarded as opportunistic. The extant literature suggests that managers split their stock when they are optimistic about their firms' future prospect, but also suggests that a stock split is only partially effective as a signal. Hence, we posit that, if managers use their reporting discretion to signal favorable private information, they are likely to do so in conjunction with stock splits. The reporting signal reinforces the stock split signal whereas the stock split signal lends credibility to the reporting signal. Consistent with our conjectures, we find that managers report significantly positive discretionary accruals in the quarter prior to a stock split and that the split announcement abnormal returns are positively correlated with the pre-split abnormal accruals. We also find no evidence that the pre-split abnormal accrual is associated with the post-split long-term abnormal return. The results suggest that, on average, at the split announcement, the market construes the pre-split discretionary accrual as a signal of managerial optimism rather than managerial opportunism.

Keywords: Discretionary accruals, Earnings management, Stock split, Signaling

JEL Classification: G12, G14, G35, M41, M43