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The use of a new instrument principal component in tests of earnings management behaviour

journal contribution
posted on 20.11.2019, 00:00 by Lan Sun
Empiricalstudieshavedocumentedvariousapproachesindetectingearningsmanagementbehaviour.Sincethemiddle 1980s, the accrual approach has become the primary focus in the literature as the accrual is suggested as a desirable vehicle to achieve managerial manipulation and it is less likely to be detected [Journal of Accounting and Economics 18 (1994), 3–42; Journal of Accounting and Public Policy 19(4,5) (2000), 313–345]. However, the accruals approach and its associated varies models in generating a valid measurement of earnings management are often criticized. A long-standing issue lies with the model misspecification where variables that explain non-discretionary accruals have been omitted from the expectation models and so wind up on the residual term, which represents the management manipulation component of discretionary accruals. As a consequence, empirical evidences on earnings management often result in misleading inferences about earnings management behaviour. Given the potential for model misspecification in measuring earnings management, this research aims to examine the validity of alternative earnings management measurement and proposes a new aggregate measure of Principal Component (PC) to be used in detecting earnings management behaviour. The principal components that explain the highest variation among accounting variables are expected to capture earnings management behavior and reveals hidden dynamics of financial reporting without model misspecification constrains.

History

Volume

2

Issue

3

Start Page

129

End Page

143

Number of Pages

15

eISSN

1875-9173

ISSN

1569-7371

Publisher

IOS Press

Peer Reviewed

Yes

Open Access

No

Era Eligible

Yes

Journal

Risk and Decision Analysis

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