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Detecting Earnings Management: A New Approach

2012; Wiley; Volume: 50; Issue: 2 Linguagem: Inglês

10.1111/j.1475-679x.2012.00449.x

1475-679X

Patricia Dechow, Amy P. Hutton, Jung Hoon Kim, Richard G. Sloan,

Financial Distress and Bankruptcy Prediction

ABSTRACT This paper provides a new approach to test for accrual‐based earnings management. Our approach exploits the inherent property of accrual accounting that any accrual‐based earnings management in one period must reverse in another period. If the researcher has priors concerning the timing of the reversal, incorporating these priors can significantly improve the power and specification of tests for earnings management. Our results indicate that tests incorporating reversals increase test power by around 40% and provide a robust solution for mitigating model misspecification arising from correlated omitted variables.