The Behavior of Earnings Quality in Different Business Cycles Using Panel Smooth Transition Regression (PSTR) Model

This paper investigates the threshold effects of business cycles on earnings quality for the period of 2005 to 2015, using Panel Smooth Transition Regression (PSTR) model as one of the most prominent regime-switching models. For this end, accruals quality and earnings smoothing are used as measures of earnings quality, and sales growth as transition variable. The linearity test results indicate nonlinear relationship among variables under consideration. Moreover, considering one transition function and one threshold parameter, as a two regime model, is sufficient to specification the nonlinear relationship among variables. The results indicate that in the first regime, business cycles have a negative impact on both earnings smoothing and accruals quality, and beyond threshold value, in the second regime, the impact of business cycles is positive. Therefore business cycles have played an important role on the earnings quality.