Testing for Income Smoothing Using the Backing Out Method: A Review of Specification Issues

Testing for Income Smoothing Using the Backing Out Method: A Review of Specification Issues This study investigates potentially spurious correlation in prior studies of income smoothing which use a research method that we call backing out. If E is reported income, Y a discretionary earnings component hypothesized to smooth income, and T the smoothing target, the backing out method consists of regressing Y on E − Y − T. A negative regression coefficient is interpreted as evidence that Y is being managed to smooth earnings. We argue that the negative regression coefficient may simply reflect the positive correlation between E and T, which may or may not be the result of manipulating Y. If E is not manipulated by Y, the negative regression coefficient reflects measurement errors in E − Y as an estimate of unmanaged earnings. http://www.deepdyve.com/assets/images/DeepDyve-Logo-lg.png Review of Quantitative Finance and Accounting Springer Journals

Testing for Income Smoothing Using the Backing Out Method: A Review of Specification Issues

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Publisher
Springer Journals
Copyright
Copyright © 2002 by Kluwer Academic Publishers
Subject
Finance; Corporate Finance; Accounting/Auditing; Econometrics; Operation Research/Decision Theory
ISSN
0924-865X
eISSN
1573-7179
D.O.I.
10.1023/A:1020719624778
Publisher site
See Article on Publisher Site

Abstract

This study investigates potentially spurious correlation in prior studies of income smoothing which use a research method that we call backing out. If E is reported income, Y a discretionary earnings component hypothesized to smooth income, and T the smoothing target, the backing out method consists of regressing Y on E − Y − T. A negative regression coefficient is interpreted as evidence that Y is being managed to smooth earnings. We argue that the negative regression coefficient may simply reflect the positive correlation between E and T, which may or may not be the result of manipulating Y. If E is not manipulated by Y, the negative regression coefficient reflects measurement errors in E − Y as an estimate of unmanaged earnings.

Journal

Review of Quantitative Finance and AccountingSpringer Journals

Published: Oct 13, 2004

References

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