Earnings Management or Measurement Error? The Effect of External Financing on Unexpected Accruals

60 Pages Posted: 17 Mar 2010 Last revised: 2 Nov 2018

See all articles by Yaowen Shan

Yaowen Shan

University of Technology Sydney; Financial Research Network (FIRN)

Stephen L. Taylor

University of Technology Sydney; Financial Research Network (FIRN)

Terry S. Walter

University of Sydney; University of Technology, Sydney - School of Finance and Economics; Financial Research Network (FIRN)

Date Written: October 14, 2013

Abstract

We demonstrate that managers’ “normal” operating decisions associated with large (positive or negative) net external financing activities are likely to lead to significant measurement errors in unexpected accruals. The problem occurs pervasively in samples drawn from different time periods, samples that reflect a wide variety of alleged earnings management stimuli, as well as random samples. Simulation tests show that even at modest levels of net external financing changes, rejection frequencies for the null hypothesis of no earnings management rise dramatically. These results are robust to controls for performance and firm growth. Further analysis suggests that net debt financing is more likely to induce measurement error than equity financing. We find that the use of a matched-firm approach using industry and external financing matches is generally appropriate. These findings highlight the importance of controlling for the effect of external financing on unexpected accruals measures, and also have implications for research testing earnings management and financial reporting quality.

Keywords: Accruals, earnings management, unexpected accruals, net external financing

JEL Classification: M40, G32

Suggested Citation

Shan, Yaowen and Taylor, Stephen L. and Walter, Terry Stirling, Earnings Management or Measurement Error? The Effect of External Financing on Unexpected Accruals (October 14, 2013). Asian Finance Association (AsianFA) 2015 Conference Paper, Available at SSRN: https://ssrn.com/abstract=1572164 or http://dx.doi.org/10.2139/ssrn.1572164

Yaowen Shan (Contact Author)

University of Technology Sydney ( email )

PO Box 123
Broadway, NSW 2007
Australia

HOME PAGE: http://profiles.uts.edu.au/Yaowen.Shan

Financial Research Network (FIRN)

C/- University of Queensland Business School
St Lucia, 4071 Brisbane
Queensland
Australia

HOME PAGE: http://www.firn.org.au

Stephen L. Taylor

University of Technology Sydney ( email )

UTS Business School
PO Box 123 Broadway
Sydney, NSW 2007
Australia
61295143437 (Phone)
61295143513 (Fax)

Financial Research Network (FIRN)

C/- University of Queensland Business School
St Lucia 4071 Brisbane
Queensland
Australia

HOME PAGE: http://www.firn.org.au

Terry Stirling Walter

University of Sydney ( email )

P.O. Box H58
Sydney, NSW 2006
Australia

University of Technology, Sydney - School of Finance and Economics ( email )

Haymarket
Sydney, NSW 2007
Australia
+61 2 9514 3860 (Phone)
+61 2 9514 7711 (Fax)

HOME PAGE: http://datasearch.uts.edu.au/business/finance/staff/StaffDetails.cfm?UnitStaffId=5373

Financial Research Network (FIRN)

C/- University of Queensland Business School
St Lucia, 4071 Brisbane
Queensland
Australia

HOME PAGE: http://www.firn.org.au

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