Measuring Discretionary Accruals: Are ROA-Matched Models Better Than the Original Jones Type Models?

• In Event: Financial Accounting & Reporting # 4
  In Paper Session: Financial Accounting and Reporting # 4

Abstract

Discretionary accruals estimated from Jones type models are elevated or depressed for firms with extreme performance. Kothari, Leone, and Wasley (2005) propose performance matching to address the issue: that is, to difference discretionary accruals estimated from Jones type models for treatment and control firms matched on current ROA. This study shows (1) performance matching will systematically cause discretionary accruals of either sign to be underestimated, and (2) the measurement error will be negatively correlated with the true discretionary accruals. As a result, using discretionary accruals estimated with performance matching to test whether certain events induce earnings management will increase the frequency of Type II errors, and using them as the dependent or an independent variable in regression analysis will bias the regression coefficient toward zero. The results of our empirical tests are consistent with these predictions.

Author

• Michael S H Shih, National University of Singapore