UC Berkeley

The current debate in the literature about whether growth drives accruals is inconclusive because accruals and growth proxies are positively correlated, and most growth proxies are accruals-based. This study first demonstrates that the implications of accruals for future firm performance are not subsumed by the non-accruals-based employee growth in a regression setting. Then I identify a subset of firms for which economic conditions cause accruals to not capture growth, thus providing a discriminating test. Specifically, I focus on firms with negative operating cycles and non-cash net working capital balances. These firms typically have declining net working capital as they grow because their business models result in current liabilities increasing more than current assets. In this setting, higher growth firms tend to have more negative accruals. Contrary to the growth hypothesis, high growth firms with low accruals experience high future profitability and returns. These findings indicate that accounting distortions embedded in accruals have distinct implications for future firm performance.