Analysis of the Impact of Accounting Accruals on Earnings Uncertainty and Response Coefficients

Abstract

This paper uses the residual income valuation model in Feltham and Ohlson (1996) as the basis for developing a model in which management has private information and their choice of accruals influences the information received by investors. The noisiness of accruals relative to management's private value relevant information is exogenous. The analysis examines how the characteristics of the management's private information and their accrual choice process influences the variance of unexpected earnings and the earnings response coefficient. The variance of unexpected earnings is shown to be an increasing function of the noise in managed accruals, but information enhancing earnings management does not necessarily decrease the variance of unexpected earnings. It depends on the nature of the information. The earnings response coefficient is shown to depend on both the persistence of earnings as well as the informativeness of reported earnings.