Accruals, Investment and Errors-in-Variables

Abstract

We formulate well-known discretionary accruals models in an investment setting. Given that accruals basically consist of short-term investment, we introduce, (i) cash-flows, as a proxy for financial constraints and other financial markets imperfections, and (ii) Tobin’s q as a measure of capital return. Accounting data and Tobin’s q being measured with errors, we propose an econometric method based on a modified version of the Hausman artificial regression which features an optimal weighting matrix of higher moments instrumental variable estimators. The empirical results suggest that all the key parameters of the discretionary accruals models studied are biased systematically with measurement errors.Discretionary accruals; Earnings management; Investment; Measurement errors; Higher moments; Instrumental variable estimators.