Does Accrual Management Impair the Performance of Earnings‐Based Valuation Models?

37 Pages Posted: 26 Feb 2015

See all articles by Lucie Courteau

Lucie Courteau

Free University of Bozen-Bolzano - Faculty of Economics and Management

Jennifer L. Kao

Independent

Yao Tian

San Jose State University

Date Written: January/February 2015

Abstract

This study examines how accrual manipulations affect firm valuation in the years surrounding the passage of the Sarbanes‐Oxley Act (SOX). We compare the absolute percentage pricing errors of RIM and DCF valuation models for a group of US firms suspected to have engaged in accrual manipulations to avoid a small loss or a small earnings decline vs. ‘Normal’ firms matched on industry, year and size. We find that RIM can better estimate intrinsic value than DCF for the matched Normal firms in the pre‐SOX period, but not so for accrual manipulators, and that SOX mitigates the harmful effect of accrual manipulations, completely eliminating the difference in RIM's accuracy advantage over DCF between Normal firms and accrual manipulators. As a further analysis, we redefine Suspect firms as real‐activity manipulators and find a significant across‐group difference in accuracy wedge in both sample periods, implying that SOX has prompted firms to favor real‐activity manipulations over accrual manipulations.

Keywords: accrual and real‐activity manipulations, firm valuation, earnings‐ and non‐earnings‐based valuation models, valuation errors, Sarbanes‐Oxley Act

Suggested Citation

Courteau, Lucie and Kao, Jennifer L. and Tian, Yao, Does Accrual Management Impair the Performance of Earnings‐Based Valuation Models? (January/February 2015). Journal of Business Finance & Accounting, Vol. 42, Issue 1-2, pp. 101-137, 2015, Available at SSRN: https://ssrn.com/abstract=2570632 or http://dx.doi.org/10.1111/jbfa.12101

Lucie Courteau (Contact Author)

Free University of Bozen-Bolzano - Faculty of Economics and Management ( email )

Faculty of Economics and Management
Piazza Università 1
39100 Bozen-Bolzano (BZ), Bozen 39100
Italy

Jennifer L. Kao

Independent

Yao Tian

San Jose State University ( email )

San Jose, CA 95192-0066
United States
6505268206 (Phone)

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