Surrogate Measures of Operating Cash Flows and Accruals: Problems and Solutions

62 Pages Posted: 28 Nov 2017 Last revised: 3 Apr 2020

See all articles by Ciao-Wei Chen

Ciao-Wei Chen

University of Illinois at Urbana-Champaign - Department of Accountancy

Sam Melessa

University of Iowa - Department of Accounting

Richard Mergenthaler

Penn State University

Heejin Ohn

University of Oklahoma

Date Written: April 1, 2020

Abstract

We examine the measurement error in surrogate measures of operating cash flows and accruals widely used in the accounting literature. We decompose the measurement error into two components, non-articulation error and omission error. We find that the measurement error is large in magnitude and primarily driven by the omission error. Furthermore, we find non-articulation events have little effect on the omission error. We demonstrate that the measurement error produces biased coefficients and incorrect inferences in four common research settings. We also provide a simple correction that eliminates the omission error and show that the correction reduces biases and improves inferences. Importantly, our decomposition and correction can be used by future researchers to identify, understand, and take steps to mitigate the measurement error and the resulting biases that are introduced when using surrogate measures of operating cash flows or accruals.

Suggested Citation

Chen, Ciao-Wei and Melessa, Sam and Mergenthaler, Richard Dean and Ohn, Heejin, Surrogate Measures of Operating Cash Flows and Accruals: Problems and Solutions (April 1, 2020). Available at SSRN: https://ssrn.com/abstract=3075461 or http://dx.doi.org/10.2139/ssrn.3075461

Ciao-Wei Chen

University of Illinois at Urbana-Champaign - Department of Accountancy ( email )

1206 South Sixth Street
Champaign, IL 61820
United States

Sam Melessa

University of Iowa - Department of Accounting ( email )

108 Pappajohn Business Building
Iowa City, IA 52242-1000
United States

Richard Dean Mergenthaler (Contact Author)

Penn State University ( email )

University Park, PA 16802-3306
United States

Heejin Ohn

University of Oklahoma ( email )

Michael F. Price College of Business
307 W Brooks, AH200F
Norman, OK 73019-4004
United States
(405) 325-5780 (Phone)

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