Identifying Accounting Quality

62 Pages Posted: 23 Aug 2014 Last revised: 15 Jan 2019

See all articles by Valeri V. Nikolaev

Valeri V. Nikolaev

University of Chicago Booth School of Business

Date Written: December 1, 2018

Abstract

I develop a new approach to understanding accounting accruals. I start by introducing a model that explicitly incorporates the role of accruals in measuring firm performance. Using this model, I characterize accounting quality by the degree to which accruals fulfill their performance measurement objective. To identify accounting quality, I exploit the property that both earnings and cash flows represent noisy measures of the unobservable economic performance, and that they converge as the measurement horizon extends. This allows decomposing the variance of accruals into both the performance measurement component and the accounting error component, as well as identifying the variance of the unobservable economic performance itself. I implement several model specifications and consider generalizations. My analysis suggests that the variance of accruals explained by performance measurement significantly exceeds the variance explained by accounting error. I conclude that accruals successfully meet their primary objective.

Keywords: Accounting quality, Earnings quality, Accruals, Identification, Estimation error

JEL Classification: M41

Suggested Citation

Nikolaev, Valeri V., Identifying Accounting Quality (December 1, 2018). Chicago Booth Research Paper No. 14-28. Available at SSRN: https://ssrn.com/abstract=2484958 or http://dx.doi.org/10.2139/ssrn.2484958

Valeri V. Nikolaev (Contact Author)

University of Chicago Booth School of Business ( email )

5807 South Woodlawn Avenue
Chicago, IL 60637
United States

HOME PAGE: http://faculty.chicagobooth.edu/valeri.nikolaev/index.html

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