Economic Determinants of Accruals Volatility and their Impact on Abnormal Accruals

• In Event: Capital Markets Research III

Abstract

This paper introduces a simple framework to understand the economic determinants of accruals volatility. First, I mathematically decompose accruals volatility into three distinct economic components: (i) the real economic volatility of the enterprise, (ii) the smoothing role of accruals, and (iii) the magnitude of accruals. Then, I show that various empirical proxies for these economic determinants explain the variation in accruals volatility over time and across companies, with predicted directions and an adjusted R2 as high as 40%. The variation in accruals volatility has a significant impact on the measure of abnormal accruals. It is because the variation in abnormal accruals is mechanically correlated with true economic variations in accruals. Consistently, I show that over 45% of variations in abnormal accruals is explained by the economic determinants of accruals volatility. These results leave an area for future research to examine whether the temporal shift in abnormal accruals documented in prior literature (e.g., Cohen, Lys, and Dey, 2008; Rajgopal and Venkatachalam, 2011) is attributable to a change in financial reporting quality or a change in real economics.

Author

• Hyun Jong Na, George Washington University