Performance Matched Discretionary Accrual Measures

Abstract

Prior research shows that extant discretionary accrual models are misspecified when applied to firms with extreme performance. Nonetheless, use of such models in tests of earnings management and market efficiency is commonplace in the literature. We examine the specification and power of the test based on a performance-matched discretionary accrual measure and compare it with traditional discretionary accrual measures (e.g., Jones and Modified-Jones Models). Performance matching is on return on assets and industry and is designed to control for the effect of performance on measured discretionary accruals. The results suggest that our performance-matched discretionary accrual measure is a viable alternative to existing discretionary accrual models for use in earnings management research.

Keywords: Earnings Management, Discretionary Accruals, Performance Matching

JEL Classification: M41, M43