The quality of accruals and earnings - and the market pricing of earnings quality

Abstract

This study focuses on earnings quality by investigating the quality of accruals using the approach introduced by Dechow & Dichev (2002). One essential element is the role of accrual estimation errors, and another is whether the equity market impounds information about the quality of earnings. The basic assumption is that the quality of accruals and earnings is decreasing as the magnitude of estimation errors in the accruals is increasing. The paper contributes to the literature on accrual (and earnings) quality by investigating not only the quality of aggregated accruals but also the quality of some more specific company key accruals, where especially the two balance sheet accounts, inventory and accounts receivable, are of interest. This is documented and discussed by relating empirical measures of the quality of the different specific key-accruals as well as aggregated accruals quality vs. observable firm characteristics (e.g. volatility of accruals and earnings, etc.). Further, since an analysis of this type in general can be said to be somewhat mechanical, it is also investigated whether and how, the equity market (e.g. observable earnings-price-ratios) impounds information about the quality of the different accruals and earnings.No; keywords