The Impact of Earnings Management on the Value-relevance of Financial Statement Information

Abstract

This paper examines the relative value-relevance of both earnings and book value in the presence of three alternative sources of earnings management: short-term discretionary accruals, long-term discretionary accruals, and total discretionary accruals. For firm's whose discretionary accruals indicate earnings management, the value-relevance of earnings is expected to be lower than for firms without earnings management. Furthermore, in the presence of earnings management, it is expected that there will be a shift from a reliance on earnings to a reliance on book value in the valuation process. This would be reflected in a decrease in the value-relevance of earnings and an increase in the value-relevance of book value. Discretionary accruals are commonly used as a measure of earnings management. A contribution of this paper is the development of models to estimate short-term and long-term discretionary accruals. This enables investigation of differential effect on value-relevance of earnings management through the use of short-term versus long-term discretionary accruals. The results demonstrate that earnings management has an impact on value-relevance. Moreover, earnings management via long-term discretionary accruals has a greater impact on the value-relevance of earnings and book value than earnings management via short-term discretionary accruals.