S.P. Kothari, Andrew J. Leone, Charles E. Wasley
We examine the specification and power of tests based on performance-matched discretionary accruals, and make comparisons with tests using traditional discretionary accrual measures (e.g., Jones and modified-Jones models). Performance matching on return on assets controls for the effect of performance on measured discretionary accruals. The results suggest that performance-matched discretionary accrual measures enhance the reliability of inferences from earnings management research when the hypothesis being tested does not imply that earnings management will vary with performance, or where the control firms are not expected to have engaged in earnings management.
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