Performance Matched Discretionary Accrual Measures

Abstract

Prior research shows extant discretionary accrual models are misspecified when applied to firms with unusual performance. Nonetheless, research on earnings management and market efficiency frequently uses these models. We examine the specification and power of tests based on performance-matched discretionary accruals, and make comparisons with tests using traditional discretionary accrual measures (e.g., Jones and modified-Jones models). Performance matching on return on assets controls for the effect of performance on measured discretionary accruals. The results suggest that performance-matched discretionary accrual measures enhance the reliability of inferences from earnings management research.

Keywords: Discretionary accruals, earnings management, performance matching, discretionary-accruals models

JEL Classification: M41, C12, C15, M43