The Different Impact of Corporate Growth on the Relationship Between Changes in Accruals and Heterogeneous Beliefs of Investors
One of the important criteria that investors, creditors, and other current and potential users use in making investment and credit decisions and other decisions, including estimating the company's profitability, predicting future profits and the risks associated with it, and evaluating management performance, is the company's current and past profits. Profit itself consists of cash and accrual items, and profit accruals are largely under the control of management, and the manager can manipulate profit accruals to improve the company's performance and increase the predictability of future profits, and so-called modern-day profit management. Managers try to create predictable and stable results by choosing authorized accounting methods. Because, most investors and managers believe that companies that have a good profitability trend and their profits do not undergo major changes have more value and better predictability and comparability than similar companies.
The Financial Accounting Standards Board believes that information about earnings and their components prepared using the accrual accounting system provides a better indicator of corporate performance. Since accrual accounting is related to the estimation of accruals, the variability of accruals can affect the quality of earnings and financial reporting and, consequently, the volatility of stock returns. On the other hand, the variability of accruals can be caused by various factors, including fundamental factors such as the economic environment and business model, or discretionary factors such as management manipulation. Most existing studies on accruals assume that corporate managers respond to economic events by adjusting accruals. Therefore, such studies typically focus on the level of accruals. Due to the reversible nature of accruals, higher levels of accruals should be associated with higher accrual variability.
Investor behavior in the stock market affects decision-making, allocation of monetary resources, pricing, and evaluation of corporate returns. Ambiguous conditions and cognitive errors rooted in human psychology cause investors to make mistakes in forming their expectations and, as a result, exhibit specific behaviors when investing in financial markets. Over the past decade, financial thinkers have tried to explain and find the causes of specific cases with the help of other sciences such as psychology, social sciences, and physics.
The set of investment opportunities or growth opportunities is related to the opportunities of the organization as well as the opportunities available in the economy to create value, and when managers have a better understanding of decision-making policies, the possibility of improving or creating value for the organization increases. Growing companies with a cost of capital rate lower than the rate of return have investment opportunities. In these companies, increasing retained earnings and converting it into capital causes an increase in stock prices. Companies are divided into three groups in their life cycle stages.
A) Growing companies: In these institutions, the cost of capital rate is lower than the expected rate of return and they have suitable investment opportunities.
B) Mature companies: In these institutions, the cost of capital is equal to the expected rate of return and they do not have suitable investment opportunities, because they do not have specific investment projects that can add to the value of the company in the competitive arena.
C) Declining companies: These institutions are in a situation where their life curve is in the final stages and their expected rate of return is less than the cost of capital.