Get access

Abnormal Accrual Estimates and Evidence of Mispricing

Authors

  • C.S. Agnes Cheng,

  • Cathy Zishang Liu,

  • Wayne Thomas

    Search for more papers by this author
    • The first author is from the Department of Accounting, E.J.Ourso College of Business, Louisiana State University and Hong Kong Polytechnic University. The second author is from the School of Accountancy, College of Business, Louisiana Tech University, and the Department of Finance, Accounting and Computer Information Systems, College of Business, University of Houston–Downtown, Texas. The third author is from the School of Accounting, Michael F. Price College of Business, University fo Oklahoma. They appreciate valuable comments from Yenn-Ru Chen and workshop participants at National Chung Kung University, Tainan, Taiwan, Peter Pope (editor) and an anonymous referee. (Paper received December 2007, revised version accepted December 2011)


Address for correspondence: C.S. Agnes Cheng, Department of Accounting, E.J. Ourso College of Business, Louisiana State University, Baton Rouge, LA 70803,USA. e-mail: acheng@lsu.edu

Abstract

Abstract:  To estimate abnormal accruals, prior research employs a wide variety of models and estimation procedures. We evaluate the performance of three representative models – modified Jones model (MJ), MJ with operating cash flows (MJOCF), and MJ with return on assets (MJROA) – and two estimation procedures – industry-specific and firm-specific regressions. In evaluating the performance of various models, we use mispricing tests (i.e., relating current accruals to future returns) as our main test. We find that the best performing model is the firm-specific MJOCF model followed by the industry-specific MJROA model. However, when we use the recursive firm-specific procedure (i.e., based on current and previous years’ information only), we do not find the firm-specific MJOCF model outperforms the industry-specific MJROA model. We recommend that researchers use the industry-specific MJROA model to estimate abnormal accruals when investigating earnings management. For evaluating earnings quality that can include management estimation error, the firm-specific MJOCF remains clearly the best model from the perspective of abnormal accrual mispricing.

Ancillary