Abstract
Errors and bias are both inherent features of accounting. In theory, while errors discourage bias by lowering the value relevance of accounting, they can also facilitate bias by providing camouflage. Consistent with theory, we find a hump-shaped relation between a firm's propensity to engage in intentional misstatement and the prevalence of unintentional misstatements in the firm's industry for the whole economy and a majority of the industries. The result is robust to using firms’ number of items in financial statements and exposure to complex accounting rules as alternative proxies for errors and to using the restatement amount in net income to quantify the magnitude of bias and errors. To directly test for the two effects of errors, we show that when errors are more prevalent, the market reacts less to firms’ earnings surprises and bias is more difficult to detect. Our results highlight the imperfectness of accounting, advance understanding of firms’ reporting incentives, and shed light on accounting standard setting.
Original language | English (US) |
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Pages (from-to) | 919-962 |
Number of pages | 44 |
Journal | Journal of Accounting Research |
Volume | 55 |
Issue number | 4 |
DOIs | |
State | Published - Sep 2017 |
Bibliographical note
Publisher Copyright:©, University of Chicago on behalf of the Accounting Research Center, 2017
Keywords
- G32
- G34
- G38
- M40
- M41
- M48
- M53
- accounting errors
- accounting regulation
- earnings response coefficient
- fraud
- fraud detection
- reporting bias
- textual analysis