Accruals Quality and Analyst Coverage

We examine the relation between analyst coverage and accruals quality. Because accrual accounting requires managers to estimate the future economic consequences of current events, accruals reflect estimation errors and potential managerial opportunism. We find that firms with low accruals quality are followed by a greater number of analysts and that a greater proportion of these analysts revise their forecasts after quarterly earnings announcements. These findings are consistent with greater demand for analyst services and more effort by analysts, as measured by forecasts revisions, when firms’ accounting numbers exhibit greater uncertainty. We also find that low accruals quality is associated with larger forecast errors and dispersion, indicating that analysts are unable to fully resolve the uncertainty in accruals. This uncertainty is consistent with accruals reflecting information risk.