Accruals, Managerial Operating Decisions, and Firm Growth: Implications for Tests of Earnings Management

One of the most crucial yet controversial issues in executive performance evaluation is disentangling which managerial decisions reflect the firm's economic position versus opportunistic earnings management. I explore this issue and find evidence that specific managerial policies often used by growing firms are likely to be identified as upward earnings management by widely-used annual accrual expectation models. I find that incorporating linear and non-linear growth measures (for various assets and from a growth factor) into these models increases the explanatory power by 1.01% to 9.86%. Models with asset growth, receivables growth, and a growth factor generate the lowest Type I error rates, while models with asset growth, operating cycle, and a growth factor generate the lowest Type II error rates. In re-examined tests of upward earnings management around IPOs, inferences change after controlling for growth. I make empirical suggestions to help distinguish growth from opportunism in tests of earnings ma...