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

  • Rajiv D. Banker
  • Dmitri Byzalov
  • Shunlan FangEmail author
  • Byunghoon Jin
Original Research
  • 25 Downloads

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 

JEL Classification

C52 D21 D22 M40 M41 

Notes

Acknowledgements

We thank Amy Hutton (discussant) and seminar participants at Temple University, JAAF Accounting Conference, Temple Accounting Conference, AAA annual meeting, FARS midyear meeting, and MAS midyear meeting for helpful comments and suggestions.

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Copyright information

© Springer Science+Business Media, LLC, part of Springer Nature 2019

Authors and Affiliations

  1. 1.Department of Accounting, Fox School of BusinessTemple UniversityPhiladelphiaUSA
  2. 2.Department of Accounting, College of BusinessKent State UniversityKentUSA
  3. 3.School of ManagementMarist CollegePoughkeepsieUSA

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