Idiosyncratic Shocks to Firm Underlying Economics and Abnormal Accruals
70 Pages Posted: 11 Dec 2013 Last revised: 1 Jun 2016
Date Written: May 15, 2016
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: Suggested Citation