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Idiosyncratic Shocks to Firm Underlying Economics and Abnormal Accruals

70 Pages Posted: 11 Dec 2013 Last revised: 1 Jun 2016

Edward L. Owens

Emory University - Department of Accounting

Joanna Shuang Wu

University of Rochester - Simon Business School

Jerold L. Zimmerman

University of Rochester - Simon Business School

Date Written: May 15, 2016

Abstract

Economics challenge the specification of discretionary accrual models. Because rent-seeking firms pursue differentiated business strategies, firms in the same industry experience idiosyncratic shocks due to heterogeneous economic fundamentals and hence have different accrual generating processes. We present evidence that idiosyncratic shocks are widespread, propagate through multiple years of financial statements, and reduce accrual models’ goodness of fit. This not only affects abnormal accrual estimates for the firm experiencing shocks, but also affects measurement of abnormal accruals for other firms in the industry. We show that idiosyncratic shocks not only add noise to abnormal accruals, but can also exacerbate bias in both unsigned and signed abnormal accruals. We propose ways to reduce accrual model misspecification.

Keywords: abnormal accruals, earnings management, earnings quality

JEL Classification: G30, M41

Suggested Citation

Owens, Edward L. and Wu, Joanna Shuang and Zimmerman, Jerold L., Idiosyncratic Shocks to Firm Underlying Economics and Abnormal Accruals (May 15, 2016). Available at SSRN: https://ssrn.com/abstract=2365304 or http://dx.doi.org/10.2139/ssrn.2365304

Edward Owens (Contact Author)

Emory University - Department of Accounting ( email )

Goizueta Business School
1300 Clifton Road
Atlanta, GA 30322
United States

Joanna Wu

University of Rochester - Simon Business School ( email )

Carol Simon Hall 3-160D
Rochester, NY 14627
United States
585-275-5468 (Phone)
585-442-6323 (Fax)

Jerold Zimmerman

University of Rochester - Simon Business School ( email )

Rochester, NY 14627
United States
585-275-3397 (Phone)
585-442-6323 (Fax)

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