Managers’ Use of External Information in Their Accrual Estimates : Evidence from the Impact of Stock Liquidity on Accruals Quality

Because stock liquidity should improve managers’ access to external information, we examine whether managers of firms with higher stock liquidity form more accurate accrual estimates. Consistent with our expectations, we find that accrual estimation errors of firms with more liquid stocks are significantly smaller. Moreover, results from a difference-in-differences test around an exogenous shock to stock liquidity (produced by the 2001 decimalization) support the idea that the external information revealed when stocks are more liquid allows managers to reduce their accrual estimation errors. Finally, we find that the negative association between stock liquidity and accrual estimation errors is stronger for firms incurring losses, operating in more volatile environments, or with higher business cyclicality. Collectively, our findings are consistent with the notion that the external information available when stocks are more liquid helps managers to form more accurate accrual estimates