Overvalued Equity and the Accruals Anomaly: Evidence from Insider Trades

This paper examines the accruals anomaly in an agency context where managers of overvalued firms have incentives to sustain overvaluation. We hypothesize that mangers anticipate the ultimate share price reversals and use high accruals to temporarily sustain overvaluation, while at the same time sell their shares. There is no incentive to deflate earnings of undervalued firms, leading to the prediction of an asymmetric relationship between trading and accruals. Our results support an agency explanation. Quadratic and binary regressions confirm that relationship between trades and accruals is concentrated on the selling side. The relationship between accruals and trading is only significant within the overvalued, low book-to-market (BM) firms. There is also evidence that low BM firms manage their earnings upward compared to high BM firms