Operating asymmetries and non-linear spline correction in discretionary accrual models

Rajiv D. Banker, Dmitri Byzalov, Shunlan Fang () and Byunghoon Jin
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Rajiv D. Banker: Temple University
Dmitri Byzalov: Temple University
Shunlan Fang: Kent State University
Byunghoon Jin: Marist College

Review of Quantitative Finance and Accounting, 2020, vol. 54, issue 3, No 2, 803-850

Abstract: Abstract Earnings management research often uses discretionary accruals from Jones-type models. These models assume a linear relation between sales changes and accruals. However, we predict and find that sales changes have a non-linear asymmetric effect on accruals through managers’ operating decisions. By forcing a linear specification on this non-linear effect, the modified Jones model overestimates (underestimates) discretionary accruals for moderate (extreme) sales changes. This non-linear bias causes excessive type-I error in tests of positive (negative) discretionary accruals for subsamples with moderate (extreme) sales growth. The literature often controls for non-linearities using performance matching (Kothari et al. in J Account Econ 39(1):163–197, 2005). However, we show that this approach leads to false inferences due to matching on the dependent variable. We use a flexible non-linear spline specification to control for the non-linear operating effect of sales changes. Our method successfully mitigates the bias, improves type-I errors without sacrificing test power, and changes inferences about major prior findings.

Keywords: Sales growth; Non-linearity; Performance matching; Misspecification (search for similar items in EconPapers)
JEL-codes: C52 D21 D22 M40 M41 (search for similar items in EconPapers)
Date: 2020
References: View references in EconPapers View complete reference list from CitEc
Citations: View citations in EconPapers (3)

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DOI: 10.1007/s11156-019-00808-5

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