Internal Control System, Earnings Quality and the Dynamics of Financial Reporting

Internal Control System, Earnings Quality and the Dynamics of Financial Reporting

RAND Journal of Economics.
2013, Vol. 44, Issue 1, Pages 145-167

 Using an earnings management model in which managers manipulate information when the firm s control system fails, I introduce a measure of earnings quality ; based on the notion of integral precision, that has solid theoretical foundations. A trade-off between the frequency and the magnitude of overstatements is shown: overstatements are larger when misreporting is less likely. Overall, the model generates a distribution of earnings announcements similar to its empirical analogue and provides a structural method to identify the likelihood and magnitude of misreporting by exploiting information from the moments of the distribution of reported earnings.