How does the corporate bond market value capital investments and accruals?

• Published in: Review of accounting studies 2009-03, Vol.14 (1), p.31-62
• Main Authors: Bhojraj, Sanjeev, Swaminathan, Bhaskaran
• Format: Article
• Language: English
• Subjects: Accounting; Accounting procedures; Accounting/Auditing; Accruals; Bond issues; Bond markets; Bond ratings; Business and Management; Capital investments; Corporate bonds; Corporate Finance; Earnings management; Investments; Investors; Mathematical models; Portfolio management; Public Finance; Risk assessment; Securities markets; Statistical analysis; Stock exchanges; Studies; Working capital
• ISSN: 1380-6653; 1573-7136
• DOI: 10.1007/s11142-007-9056-x

This paper examines whether the mispricing of accruals documented in equity markets extends to bond markets. The paper finds that corporate bonds of firms with high operating accruals underperform corporate bonds of firms with low operating accruals. In the first year after portfolio formation, the underperformance is 115 basis points using an accrual measure that includes capital investments and 93 basis points using an accrual measure that is based only on working capital investments. The Sharpe ratios of the zero-investment bond accrual portfolios are comparable to those of the corresponding zero-investment stock accrual portfolios. The results are also robust to risk adjustments based on both a factor model consisting of the Fama and French ( J. Financial Econ 33 ( 1993 ) 3) stock and bond market factors and a characteristics model based on bond ratings and duration. Cross-sectional Fama–MacBeth regressions that use individual bond data and control for stock and bond issuances in addition to ratings and duration also confirm the time-series portfolio findings. Overall, our results reveal an accrual anomaly among bonds similar to that observed among stocks.