Operating Asymmetries and Non-Linear Spline Correction in Discretionary Accrual Models

56 Pages Posted: 28 Feb 2018 Last revised: 17 May 2018

See all articles by Rajiv D. Banker

Rajiv D. Banker

Temple University - Department of Accounting

Dmitri Byzalov

Temple University - Fox School of Business and Management - Department of Accounting

Shunlan Fang

Kent State University

Byunghoon Jin

Marist College

Date Written: May 17, 2018

Abstract

Earnings management research often uses discretionary accruals from Jones-type models. These models assume a linear relation between sales changes and accruals. However, we predict and find that sales changes have a non-linear asymmetric effect on accruals through managers’ operating decisions. By forcing a linear specification on this non-linear effect, the modified Jones model overestimates (underestimates) discretionary accruals for moderate (extreme) sales changes. This non-linear bias causes excessive type-I error in tests of positive (negative) discretionary accruals for subsamples with moderate (extreme) sales growth. The literature often controls for non-linearities using performance matching (Kothari et al. [2005]). However, we show that this approach leads to false inferences due to matching on the dependent variable. We use a flexible non-linear spline specification to control for the non-linear operating effect of sales changes. Our method successfully mitigates the bias, improves type-I errors without sacrificing test power, and changes inferences about major prior findings.

Suggested Citation

Banker, Rajiv D. and Byzalov, Dmitri and Fang, Shunlan and Jin, Byunghoon, Operating Asymmetries and Non-Linear Spline Correction in Discretionary Accrual Models (May 17, 2018). Fox School of Business Research Paper No. 18-011. Available at SSRN: https://ssrn.com/abstract=3126329 or http://dx.doi.org/10.2139/ssrn.3126329

Rajiv D. Banker

Temple University - Department of Accounting ( email )

Philadelphia, PA 19122
United States

Dmitri Byzalov (Contact Author)

Temple University - Fox School of Business and Management - Department of Accounting ( email )

Philadelphia, PA 19122
United States

HOME PAGE: http://astro.temple.edu/~dbyzalov/

Shunlan Fang

Kent State University ( email )

Kent, OH 44242
United States

Byunghoon Jin

Marist College ( email )

United States

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