The Accrual Effect on Future Earnings

35 Pages Posted: 18 Nov 2003

See all articles by Narasimhan Jegadeesh

Narasimhan Jegadeesh

Emory University - Department of Finance

Konan Chan

National Chengchi Unversity (NCCU) - Finance

Theodore Sougiannis

University of Illinois at Urbana-Champaign - Department of Accountancy

Multiple version iconThere are 2 versions of this paper

Date Written: September 2003

Abstract

Earnings manipulation has become a widespread practice for US corporations. However, most studies in the literature focus on whether certain incentives would facilitate managers to manipulate earnings and there has been little evidence documenting the consequences of earnings manipulation. This paper fills this gap by examining how current accruals affect future earnings (the accrual effect) and measuring the size of this effect. We find that the aggregate future earnings will decrease by $0.046 and $0.096, respectively, in the next one and three years for a $1 increase of current accruals. Over the very long-term (25 years), 20% of current accruals will reverse. This negative accrual effect is more significant for firms with high price-earnings ratios, high market-to-book ratios and high accruals where earnings management is more likely to occur. We show that incorporating the accrual effect is useful in improving the accuracy of earnings forecasts for these firms. Accordingly, the empirical results are consistent with the notion that earnings management causes the negative relationship between current accruals and future earnings. In addition, this paper shows that one recently developed accrual model has better performance than the popularly cited model in identifying manipulated earnings.

JEL Classification: M41, M43

Suggested Citation

Jegadeesh, Narasimhan and Chan, Konan and Sougiannis, Theodore, The Accrual Effect on Future Earnings (September 2003). Available at SSRN: https://ssrn.com/abstract=458382 or http://dx.doi.org/10.2139/ssrn.458382

Narasimhan Jegadeesh

Emory University - Department of Finance ( email )

Atlanta, GA 30322-2710
United States

Konan Chan (Contact Author)

National Chengchi Unversity (NCCU) - Finance ( email )

No. 64, Chih-Nan Road
Section 2
Taipei, 11623
Taiwan
+886-2-29393091 ext 81239 (Phone)

Theodore Sougiannis

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

360 Wohlers Hall
1206 South Sixth Street
Champaign, IL 61820
United States
217-244-0555 (Phone)
217-244-0902 (Fax)

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