Earnings Quality Metrics and What They Measure

62 Pages Posted: 24 Oct 2010 Last revised: 16 Aug 2011

See all articles by Ralf Ewert

Ralf Ewert

University of Graz - Institute of Accounting and Auditing

Alfred Wagenhofer

University of Graz

Date Written: August 16, 2011

Abstract

This paper provides a theory of earnings quality metrics, explaining what they capture and how they are related with each other. We develop a simple economy in which a manager has market price, earnings, and smoothing incentives and can bias earnings reports. This economy provides a framework for the analysis of earnings quality metrics. We express value relevance, persistence, predictability, smoothness, and discretionary accruals in terms of their primitives, the manager’s incentives, operating risk, and accounting noise, and examine their behavior on varying these primitives. We find that some of them, particularly value relevance and persistence, trace closely the change in information content in our setting. In contrast, smoothing and discretionary accruals reflect the rational market reaction to the earnings reports inconsistently. These results provide guidance for understanding and selecting metrics in empirical tests.

Keywords: Earnings Quality, Accounting Quality, Value Relevance, Earnings Management, Discretionary Accruals

JEL Classification: M41, G14

Suggested Citation

Ewert, Ralf and Wagenhofer, Alfred, Earnings Quality Metrics and What They Measure (August 16, 2011). Available at SSRN: https://ssrn.com/abstract=1697042 or http://dx.doi.org/10.2139/ssrn.1697042

Ralf Ewert (Contact Author)

University of Graz - Institute of Accounting and Auditing ( email )

Universitaetsstr. 15/F1
Graz, A-8010
Austria
+43 (0) 316 380-3470 (Phone)
+43 (0) 316 380-9540 (Fax)

HOME PAGE: http://www.uni-graz.at/iuwp/

Alfred Wagenhofer

University of Graz ( email )

Austria
+43 316 380 3500 (Phone)
+43 316 380 9565 (Fax)

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