The Implications of Accounting Distortions and Growth for Accruals and Profitability
Scott A. Richardson
London Business School; AQR Capital Management, LLC
Richard G. Sloan
University of California at Berkeley - Haas School of Business
Mark T. Soliman
University of Southern California - Marshall School of Business
A. Irem Tuna
London Business School
Following Sloan (1996), numerous studies show that the accrual component of earnings is less persistent than the cash flow component of earnings. Disagreement exists, however, as to the explanation for this result. Xie (2001) attributes the result to managerial discretion. Fairfield et al. (2003a) argue that it is a special case of a more general growth anomaly that is attributable to the widespread use of conservative accounting methods and/or diminishing marginal returns to new investment. Finally, Dechow and Dichev (2002) and Richardson et al. (2004) argue that it is attributable to transitory accrual estimation error. In this paper, we provide theory and evidence to discriminate between these alternative explanations. Our analysis suggests that transitory accrual estimation error provides the most consistent explanation for the lower persistence of the accrual component of earnings. Further, our results suggest the accrual estimation error is at least partially attributable to managerial discretion.
Number of Pages in PDF File: 53
Keywords: Accruals, earnings management, conservative accounting, aggressive accounting
JEL Classification: M41, M43, M44
Date posted: March 26, 2004
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