Construction of AQfactor

The construction of AQfactor starts with identifying all firms with the necessary data to estimate the underlying accruals quality metric, developed by Dechow and Dichev (2002) and modified by McNichols (2002). Requiring a minimum of 20 firms per industry-year, we run annual cross-sectional regressions of total current accruals on past, present and future cash flows from operations, as well as on gross property, plant and equipment and the change in sales revenues, separately for each of the 48 Fama-French (1997) industries. Accruals quality at the end of Year T (AQ) is the standard deviation of the five firm- and year-specific residuals obtained from the regressions in Years T-5 to T-1. Lagging AQ by one year accounts for the fact that the industry regressions contain the leading cash flow from operations.

We assign firms to AQ deciles using a dynamic portfolio technique that allows for differences in firms' fiscal year ends as well as over-time changes in accruals quality. Specifically, we further lag the AQ metric by three months after fiscal year end to ensure public availability of the accounting data and then form deciles on the first day of each month based on the firm's most recent value of AQ. If the AQ signal for the following fiscal year is missing due to insufficient data, the firm is excluded from this portfolio formation after twelve months (but allowed to re-enter the portfolio later). Finally, AQfactor is defined as the equal-weighted daily return of the four deciles of firms with the highest (=poorest) AQ less the equal-weighted daily return of the four deciles of firms with the lowest (=best) AQ.

The file ‘AQfactor 1970-2003.xls' contains the 8,586 daily portfolio returns from 1970 to 2003. For a more detailed description about the procedure, including Compustat variable numbers, etc., please refer to the published article.