Does Accrual Management Impair the Performance of Earnings-Based Valuation Models?
This study examines empirically how the presence of accrual management may affect firm valuation. We compare the performance of earnings-based and non-earnings-based valuation models, represented by Residual Income Model (RIM) and Discounted Cash Flow (DCF), respectively, based on the absolute percentage pricing and valuation errors for two subsets of US firms: “Suspect” firms that are likely to have engaged in accrual management and “Normal” firms matched on industry, year and size. Results indicate that RIM enjoys an accuracy advantage over DCF when accrual management is not a serious concern. However, the presence of accrual management significantly narrows RIM’s accuracy advantage over DCF from the level observed for the matched Normal firms. These results are robust to the choice of model benchmark (i.e., current stock price vs. ex post intrinsic value), alternative definitions of Suspect (i.e., loss or earnings-decline avoidance vs. earnings-decline avoidance only vs. loss avoidance only) and of Normal firms (i.e., excluding vs. including real activity manipulators), and different assumptions about post-horizon growth (i.e., 2% vs. 4%). The overall conclusion that accrual management impairs RIM’s performance extends to settings where the regression model is expanded to include accrual components and when we focus on large, rather than small, earnings manipulators. Taken together, these results highlight the importance of considering earnings quality when assessing the performance of earnings-based valuation models.
|Date of creation:||Jul 2013|
|Date of revision:|
|Contact details of provider:|| Postal: VIA SERNESI, 1 - 39100 BOLZANO|
Phone: +39 0471 315 000
Fax: +39 0471 315 009
Web page: http://www.unibz.it/en/economics/research/workingpapers/default.html
More information through EDIRC
Please report citation or reference errors to , or , if you are the registered author of the cited work, log in to your RePEc Author Service profile, click on "citations" and make appropriate adjustments.:
- François Degeorge & Jayendu Patel & Richard Zeckhauser, 1997.
"Earnings Management to Exceed Thresholds,"
- Fama, Eugene F. & French, Kenneth R., 1993. "Common risk factors in the returns on stocks and bonds," Journal of Financial Economics, Elsevier, vol. 33(1), pages 3-56, February.
- Frankel, Richard & Lee, Charles M. C., 1998. "Accounting valuation, market expectation, and cross-sectional stock returns," Journal of Accounting and Economics, Elsevier, vol. 25(3), pages 283-319, June.
- Erickson, Merle & Wang, Shiing-wu, 1999. "Earnings management by acquiring firms in stock for stock mergers," Journal of Accounting and Economics, Elsevier, vol. 27(2), pages 149-176, April.
- Burgstahler, David & Dichev, Ilia, 1997. "Earnings management to avoid earnings decreases and losses," Journal of Accounting and Economics, Elsevier, vol. 24(1), pages 99-126, December.
- Harrison Hong & Jeffrey D. Kubik, 2003. "Analyzing the Analysts: Career Concerns and Biased Earnings Forecasts," Journal of Finance, American Finance Association, vol. 58(1), pages 313-351, 02.
- Salma S. Ibrahim, 2009. "The Usefulness of Measures of Consistency of Discretionary Components of Accruals in the Detection of Earnings Management," Journal of Business Finance & Accounting, Wiley Blackwell, vol. 36(9-10), pages 1087-1116.
- Charles M. C. Lee & James Myers & Bhaskaran Swaminathan, 1999. "What is the Intrinsic Value of the Dow?," Journal of Finance, American Finance Association, vol. 54(5), pages 1693-1741, October.
- Roychowdhury, Sugata, 2006. "Earnings management through real activities manipulation," Journal of Accounting and Economics, Elsevier, vol. 42(3), pages 335-370, December.
- Siew Hong Teoh & Ivo Welch & T.J. Wong, 1998. "Earnings Management and the Long-Run Market Performance of Initial Public Offerings," Journal of Finance, American Finance Association, vol. 53(6), pages 1935-1974, December.
- Klein, April, 2002. "Audit committee, board of director characteristics, and earnings management," Journal of Accounting and Economics, Elsevier, vol. 33(3), pages 375-400, August.
- Bowen, Robert M. & DuCharme, Larry & Shores, D., 1995. "Stakeholders' implicit claims and accounting method choice," Journal of Accounting and Economics, Elsevier, vol. 20(3), pages 255-295, December.
- Healy, Paul M., 1985. "The effect of bonus schemes on accounting decisions," Journal of Accounting and Economics, Elsevier, vol. 7(1-3), pages 85-107, April.
- Michael Ettredge & Susan Scholz & Kevin R. Smith & Lili Sun, 2010. "How Do Restatements Begin? Evidence of Earnings Management Preceding Restated Financial Reports," Journal of Business Finance & Accounting, Wiley Blackwell, vol. 37(3-4), pages 332-355.
- Mark T. Bradshaw & Scott A. Richardson & Richard G. Sloan, 2001. "Do Analysts and Auditors Use Information in Accruals?," Journal of Accounting Research, Wiley Blackwell, vol. 39(1), pages 45-74, 06.
- Dechow, Patricia M. & Hutton, Amy P. & Sloan, Richard G., 1999. "An empirical assessment of the residual income valuation model1," Journal of Accounting and Economics, Elsevier, vol. 26(1-3), pages 1-34, January.
- Steven Balsam, 2002. "Accruals Management, Investor Sophistication, and Equity Valuation: Evidence from 10-Q Filings," Journal of Accounting Research, Wiley Blackwell, vol. 40(4), pages 987-1012, 09.
When requesting a correction, please mention this item's handle: RePEc:bzn:wpaper:bemps12. See general information about how to correct material in RePEc.
For technical questions regarding this item, or to correct its authors, title, abstract, bibliographic or download information, contact: (bemps administrator)
If references are entirely missing, you can add them using this form.