Detecting Earnings Management: A New Approach

Authors

  • PATRICIA M. DECHOW,

    1. The Haas School of Business, University of California, Berkeley
    Search for more papers by this author
  • AMY P. HUTTON,

    1. Carroll School of Management, Boston College
    Search for more papers by this author
  • JUNG HOON KIM,

    1. School of Accounting, Florida International University. We are grateful for the comments of the referee, Phil Berger (the Editor), Frank Ecker, Jennifer Francis, Joseph Gerakos (the discussant), Maureen McNichols, Per Olsson, Katherine Schipper and workshop participants at the 2011 Journal of Accounting Research Conference, the 2011 American Accounting Association Annual Meetings, the University of Arizona, the University of California Los Angeles, Brigham Young University, the University of Houston, the University of Texas at Austin, and the University of Washington.
    Search for more papers by this author
  • RICHARD G. SLOAN

    1. The Haas School of Business, University of California, Berkeley
    Search for more papers by this author

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.

Ancillary