Numerous accounting studies claim that investors fail to rationally price accrual-related information and that investors are functionally fixated. This study documents the importance of performing robustness tests when testing economic or behavioral explanations for apparent accounting-related security mispricing. We find that performing robustness tests that exclude a small number of firm-year observations (approximately 200 firm-year observations or about 1% of the entire sample) reveals an inverted U-shaped relation between buy-and-hold abnormal returns and total accruals. An inverted U-shaped relation is inconsistent with the functional fixation (earnings fixation) hypothesis. We conduct similar robustness tests for the abnormal accrual anomaly and the net operating assets anomaly proposed by other investigators, and also find an inverted U-shaped relation between buy-and-hold abnormal returns and abnormal accruals and net operating assets. These findings are inconsistent with the explanations put forth by those investigators. Such evidence leads us to conclude that the accrual-related anomalies are unlikely to be due to investors' inability to process accounting information, as suggested by the functional fixation hypotheses tested. Copyright University of Chicago on behalf of the Institute of Professional Accounting, 2006.

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The test developed in Mishkin [1983] (hereafter, MT) is widely used to test the rational pricing of accounting numbers. However, contrary to the perception in the accounting literature, the exclusion of variables from the MT's forecasting and pricing equations leads to an omitted variables problem that affects inferences about the rational pricing of accounting variables. Only if the omitted variables are rationally priced is their exclusion irrelevant. Failure to recognize this issue leads accounting researchers to employ the MT without appreciating how omitted variables affect the inferences they draw. We demonstrate that when additional explanatory variables are included in the MT, the rational pricing of accruals is not rejected. That is, the accrual anomaly documented in Sloan [1996] vanishes when additional explanatory variables are incorporated into the MT. We also show that in accounting research settings, where samples are large, ordinary least squares (OLS) is equivalent to * London Business School; †Penn State University; ‡University of Rochester. We have benefited from comments and suggestions made by seminar participants at The the MT. As a result, accounting researchers should consider using OLS or be more explicit about the exact advantages of the MT over OLS in their research setting. because interest rate and treasury bond data do not suffer from issues of survival like firm-level accounting numbers do. In accounting, however, the bias is significant. For example, Kraft, Leone, and Wasley [2006] report that the buy-and-hold size-adjusted return of a portfolio consisting of NYSE/AMEX firms in the lowest accrual decile is 4.2% when this selection bias is present compared to 1.8% when it is not present. In addition, in a sample of New York Stock Exchange (NYSE)/American Stock Exchange (AMEX)/NASDAQ firms, Hafzalla, Lundholm, and Van Winkle [2007] report that the returns go from 12.3% when this bias is present down to 2.7% when it is absent.

This is the accepted version of the paper.This version of the publication may differ from the final published version. Abstract: Using the transition of US firms from annual reporting to semi-annual reporting and then to quarterly reporting over the period 1950-1970, we provide evidence on the effects of increased reporting frequency on firms' investment decisions. Estimates from difference-in-differences specifications indicate that increased reporting frequency is associated with an economically large decline in investments. Additional analyses reveal that the decline in investments is most consistent with frequent financial reporting inducing myopic management behavior. Our evidence informs the recent controversial debate about eliminating quarterly reporting for US corporations. Permanent repository linkJEL Classification: M40, M41, G30, G31