Implications of Nondiscretionary Accruals for Earnings Management and Market-Based Research

Abstract

This paper evaluates the implications of nondiscretionary accruals for earnings management and market-based accounting research. We develop a simple model in which earnings management is absent and nondiscretionary accruals perform their intended function of insulating earnings from non-cash working capital shocks. Our analysis indicates that existing techniques for measuring earnings management are likely to misclassify some nondiscretionary accruals as discretionary accruals. Further, we show that certain 'significant' results in existing earnings management research are consistent with the misclassification of nondiscretionary accruals. Finally, we provide a framework for understanding the pricing of cash flow and nondiscretionary accrual components of earnings.