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The Implications of Accounting Distortions and Growth for Accruals and Profitability

53 Pages Posted: 26 Mar 2004  

Scott A. Richardson

AQR Capital Management, LLC; London Business School

Richard G. Sloan

University of California, Berkeley - Accounting Group; University of Southern California - Leventhal School of Accounting

Mark T. Soliman

University of Southern California - Marshall School of Business

A. Irem Tuna

London Business School

Multiple version iconThere are 2 versions of this paper

Date Written: March 2004

Abstract

Following Sloan (1996), numerous studies show that the accrual component of earnings is less persistent than the cash flow component of earnings. Disagreement exists, however, as to the explanation for this result. Xie (2001) attributes the result to managerial discretion. Fairfield et al. (2003a) argue that it is a special case of a more general growth anomaly that is attributable to the widespread use of conservative accounting methods and/or diminishing marginal returns to new investment. Finally, Dechow and Dichev (2002) and Richardson et al. (2004) argue that it is attributable to transitory accrual estimation error. In this paper, we provide theory and evidence to discriminate between these alternative explanations. Our analysis suggests that transitory accrual estimation error provides the most consistent explanation for the lower persistence of the accrual component of earnings. Further, our results suggest the accrual estimation error is at least partially attributable to managerial discretion.

Keywords: Accruals, earnings management, conservative accounting, aggressive accounting

JEL Classification: M41, M43, M44

Suggested Citation

Richardson, Scott A. and Sloan, Richard G. and Soliman, Mark T. and Tuna, A. Irem, The Implications of Accounting Distortions and Growth for Accruals and Profitability (March 2004). Available at SSRN: https://ssrn.com/abstract=521043 or http://dx.doi.org/10.2139/ssrn.521043

Scott Anthony Richardson

AQR Capital Management, LLC ( email )

Greenwich, CT
United States

London Business School ( email )

Sussex Place
Regent's Park
London, London NW1 4SA
United Kingdom

Richard G. Sloan (Contact Author)

University of California, Berkeley - Accounting Group ( email )

Haas School of Business
Berkeley, CA 94720
United States

University of Southern California - Leventhal School of Accounting ( email )

Los Angeles, CA 90089-0441
United States

Mark T. Soliman

University of Southern California - Marshall School of Business ( email )

Los Angeles, CA 90089
United States

Ayse Irem Tuna

London Business School ( email )

Sussex Place
Regent's Park
London, London NW1 4SA
United Kingdom

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