Abstract
The aim of this study was to investigate two aspects of accounting information that may be inherently related: income smoothing practices and conditional conservatism. Theoretically, the more a firm employs income smoothing, i.e., uses accruals to reduce the variability of profits, the less possibility there is for the timely acknowledgement of future economic losses (i.e., bad economic news) in profits. Eckel's model (1981) was used in this study to classify listed companies as smoothing or non-smoothing, and Basu's model (1997) was used to quantify the degree of conditional conservatism present in each firm. To make the results more robust, samples were created with annual stock return data from both March and December. The results indicated that non-smoothing firms had a higher degree of conditional conservatism, i.e., more opportunity to recognize future economic losses because the market could use the stock return data to anticipate future losses contained in the information regarding profits. This research made it possible to observe theoretical relationships between properties of accounting information: i) there is a relationship between income smoothing and conditional conservatism (i.e., accounting choices); ii) the informational environment of the Brazilian capital market contributes to the market distinction between smoothing and non-smoothing firms; and iii) the improvement of the capital market provides economic operators with greater insight into economic losses that are contained in accounting results.
Highlights
To date, the quality of accounting information cannot be measured by a single variable
Almeida (2010) found that the quality of accounting information that uses the metrics of relevance, timeliness, conservatism, and earnings management varies depending on the degree of competition in the environment in which firms operate
It was necessary to exclude observations that could not be classified as income smoothing or nonsmoothing because they had coefficient of variation values, which are discussed in section 3.2.1, that fell within a band called a gray area
Summary
The quality of accounting information cannot be measured by a single variable. The interference of executives who smooth the incomes of their firms to reduce the variability of the firms’ profits can reduce the ability of stock returns to capture future economic losses included in profits or can conceal the extent of the firm's risk, as measured by variance in the accounting results over time (Dechow, Sloan, & Sweeny, 1995) Several studies, such as those conducted by Coelho and Lima (2007, 2009) and Barth, Landsman, & Lang (2008), suggest that these properties may be directly related and that one can affect the other. Section five brings the final considerations together with ideas and suggestions for further research
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