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The Use of Unsigned Earnings Quality Measures in Tests of Earnings Management

37 Pages Posted: 11 Dec 2007  

Paul Hribar

University of Iowa - Henry B. Tippie College of Business

D. Craig Nichols

Cornell University - Samuel Curtis Johnson Graduate School of Management

Multiple version iconThere are 2 versions of this paper

Date Written: 2007-05-29

Abstract

This paper examines the implications of using the absolute value of discretionary accruals when testing for earnings management. First, we analytically develop the mean and variance of the distribution of absolute discretionary accruals, and show that the expected value is an increasing function of the variance in the underlying error term from the first-stage discretionary accrual estimation model. Second, we highlight several firm characteristics that are related to the error variance in discretionary accrual estimation models. Using simulations, we show that correlation between the earnings management partitioning variable and these firm characteristics leads to an overrejection of the null hypothesis of no earnings management. Third, we provide research design suggestions to help researchers mitigate the potential bias arising from the use of unsigned measures of earnings management. Using these suggestions, we replicate a recent study, and demonstrate that the inferences change after controlling for operating volatility.

JEL Classification: G30, M41, M43

Suggested Citation

Hribar, Paul and Nichols, D. Craig, The Use of Unsigned Earnings Quality Measures in Tests of Earnings Management (2007-05-29). Journal of Accounting Research, Vol. 45, Issue 5, pp. 1017-1053, December 2007. Available at SSRN: https://ssrn.com/abstract=1065892 or http://dx.doi.org/10.1111/j.1475-679X.2007.00259.x

Paul Hribar (Contact Author)

University of Iowa - Henry B. Tippie College of Business ( email )

Dept. of Accounting
Iowa City, IA 52242-1000
United States
319-335-1008 (Phone)

D. Craig Nichols

Cornell University - Samuel Curtis Johnson Graduate School of Management ( email )

Ithaca, NY 14853
United States

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