Economic Relations Among Earnings Quality Measures

45 Pages Posted: 3 Sep 2015

See all articles by Ralf Ewert

Ralf Ewert

University of Graz - Institute of Accounting and Auditing

Alfred Wagenhofer

University of Graz

Multiple version iconThere are 2 versions of this paper

Date Written: September 2015

Abstract

Empirical studies on earnings quality use various measures that capture particular dimensions of earnings quality. This paper provides a theoretical foundation to evaluate and compare several common earnings quality measures: value relevance; persistence; predictability; smoothness; and discretionary accruals. We use a rational expectations framework in which a manager has market price, earnings, and smoothing incentives and can bias earnings reports. Taking the information content of reported earnings as a natural benchmark, we determine how variations of management incentives, operating risk, and accounting noise affect earnings quality and examine whether the different measures point in the same or in the opposite direction. We find that value relevance and persistence are measures that are closely aligned with each other and with our benchmark, followed by predictability and smoothness. Discretionary accruals measures are less aligned because they are based on the level of accruals, which confounds their information content. Our results also support the notion that smoother earnings and higher discretionary accruals are associated with greater earnings quality.

Keywords: Accounting quality, Discretionary accruals, Earnings attributes, Earnings quality, Earnings smoothing, Value relevance

Suggested Citation

Ewert, Ralf and Wagenhofer, Alfred, Economic Relations Among Earnings Quality Measures (September 2015). Abacus, Vol. 51, Issue 3, pp. 311-355, 2015. Available at SSRN: https://ssrn.com/abstract=2655178 or http://dx.doi.org/10.1111/abac.12054

Ralf Ewert (Contact Author)

University of Graz - Institute of Accounting and Auditing ( email )

Universitaetsstr. 15/F1
Graz, A-8010
Austria
+43 (0) 316 380-3470 (Phone)
+43 (0) 316 380-9540 (Fax)

HOME PAGE: http://www.uni-graz.at/iuwp/

Alfred Wagenhofer

University of Graz ( email )

Austria
+43 316 380 3500 (Phone)
+43 316 380 9565 (Fax)

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