Cost Stickiness and Accrual Models

Previous research has shown that costs exhibit a sticky behavior: Costs increases when sales rise are larger than cost decreases when sales drop. Given that the traditional accrual models rely on the assumption of costs responding equally to sales increases and to sales decreases, the sticky behavior of costs can make these models misspecified. In this paper, we analyze how cost stickiness affects to three of the most common accrual models –the Jones model (J. Jones, 1991), the Dechow and Dichev model (P. Dechow & Dichev, 2002), and the McNichols model (Maureen McNichols, 2002)– and provide modifications of those models to control for cost stickiness. Our results show that the Jones model is misspecified in sumbsamples of sales decreases, whereas the Dechow and Dichev model and the McNichols model are misspeficied in both samples of sales increases and sales decreases. Controlling for the sign of the sales variation contributes to mitigate such misspecification, as well as to increase their power for detecting positive manipulations in sales-decreasing companies and negative manipulations in sales-increasing companies.