Journal of Accounting and Economics Vol. 69 No. 2-3 2020
Using a hidden Markov model to measure earnings quality
open access
Abstract
We propose and validate a new measure of earnings quality based on a hidden Markov model. This measure, termed earnings fidelity, captures how faithful earnings signals are in revealing the true economic state of the firm. We estimate the measure using a Markov chain Monte Carlo procedure in a Bayesian hierarchical framework that accommodates cross-sectional heterogeneity. Earnings fidelity is positively associated with the forward earnings response coefficient. It significantly outperforms existing measures of quality in predicting two external indicators of low-quality accounting: restatements and Securities and Exchange Commission comment letters.
- DOI
- 10.1016/j.jacceco.2019.101281
- Volume
- 69
- Issue
- 2-3
- Pages
- 101281
- Language
- en
- Sources
- bibtex:phds-export.bib openalex crossref