Smooth Earnings Research Articles

Taking a long view: Investor trading horizon and earnings management strategy

AbstractThis paper studies how the investment horizon of institutional investors affects firms' earnings management strategy in terms of trade‐off decisions between accrual management and operational adjustment. We find that when overall earnings management motives are held fixed, firms in which long‐term investors hold large stakes are more likely to manage earnings by adjusting operational decisions than by manipulating accruals. The preference for real earnings management is more pronounced when long‐term investors face performance pressures and when they have a strong influence on managers. We further document that real earnings management helps smooth earnings, and the future adverse consequences of operational adjustment are relatively less severe for firms with a greater proportion of long‐term investors than for those with more short‐term investors. Our findings are robust to the endogenous choice of ownership structure. Overall, the evidence suggests that firms choose earnings management methods to meet the earnings expectations of institutional investors, who have different earnings target windows.

Would an Improved Information Environment of a Less Regulated OTC Market Benefit Blue-Chip Foreign Firms? Evidence from the OTCQX International Market

ABSTRACT This study examines whether an improved information environment in the OTCQX International market (hereafter QX market) benefits blue-chip foreign private issuers (FPIs). We find that around 600 FPIs traded their stocks in the QX market during 2007–2016, and they are financially better than their home-country counterparts. We also find approximately 6 percent abnormal return around the cross-listing days. Moreover, FPIs with higher financial reporting transparency (i.e., lower earnings smoothness and preparing financial statements in accordance with International Financial Reporting Standards) experience more pronounced abnormal returns and liquidity improvement around cross-listing. Further analysis shows the market premium of cross-listing on the QX market is not attributed to the bonding effect. Our results highlight the importance of the information environment of a less regulated OTC market in benefiting large and established FPIs, which should be of interest to regulators, investors, and foreign firms intended to access less regulated U.S. markets.

The Effects of Blockholder Dispersion on the Informativeness of Earnings: Evidence from Korea

This paper studies the relationship between blockholder dispersion and the informativeness of earnings using a sample of Korean companies. Investors prefer less volatile and more sustainable earnings and managers have incentives to manage earnings to meet investor demand. We show evidence that firms with dispersed ownership, which are likely to suffer from high levels of information asymmetry, smooth earnings in order to relieve investors’ concerns regarding information asymmetry. Furthermore, our regression analyses on the relation between returns and future earnings reveal that earnings smoothing conducted by firms with dispersed ownership leads to higher informativeness of earnings. This study provides important implications for various financial statement users in interpreting firms’ earnings sustainability, especially in the East Asian countries where a wide spectrum of ownership concentration structure exists.

Corporate Managerial Ability, Earnings Smoothing, and Acquisitions

This paper examines whether high-ability managers’ earnings smoothing is motivated by the need to mitigate the adverse effects of heightened information asymmetry, triggered by mergers and acquisitions (M&As), on managers’ reputation capital (job loss) and firm value. We document that acquirers led by high-ability managers engage in more pre-acquisition earnings smoothing and experience more significant announcement abnormal returns and operating performance in post-M&A periods than their low-ability counterparts. This result is consistent with the theory of managerial response to asymmetric information amplified by M&As, where high-ability managers use earnings smoothing as a signaling device to ensure that the market quickly discovers their superior abilities, to increase acquirers’ future growth prospects and avoid the adverse effects of information asymmetry on managers’ job security and career prospects in a competitive executive labor market.

Annual Earnings Guidance and the Smoothing of Analysts’ Multi-Period Forecasts

This article examines the use of annual earnings guidance as a mechanism used by managers to reduce the volatility of analyst earnings forecasts and allow them to report smooth earnings without missing quarterly analyst forecasts. Facing the pressure to meet or beat analyst forecasts and driven by the perceived capital market benefits of reporting a smooth earnings path, managers attempting to influence investors’ earnings expectations over a longer horizon can issue annual guidance to smooth the time-series path of analyst forecasts, a strategy we term as “expectation smoothing.” Our empirical results suggest that annual guidance reduces the volatility of analysts’ multi-period forecasts, which in turn contributes to a smoother actual earnings and higher likelihood of meeting analysts’ quarterly forecasts. We also find that issuing quarterly guidance does not affect the smoothness of analysts’ earnings expectations and that managers with longer horizons are more likely to issue annual guidance, consistent with the unique long-term effects of annual earnings guidance.

CEO inside debt, income smoothing, and stock price informativeness

I examine whether the informativeness of income smoothing varies with the extent to which the CEO holds inside debt (i.e. pension benefits and deferred compensation). I document that for firms where the CEO holds less inside debt, income smoothing reduces stock price informativeness. This result suggests that CEOs with lower inside debt smooth earnings to conceal firms’ underlying economic performance. I also find that the negative effect of income smoothing on stock price informativeness for firms whose CEOs hold less inside debt is more pronounced when firms have higher debt financing, lower analyst coverage, or weaker corporate governance.

Earnings Smoothing and Strategic Change

To understand a firm's strategy we must understand when they will engage in strategic change vs. persist with current activities. A precursor of strategic change that is often studied is performance feedback; it is often found that higher levels of performance (particularly above salient historical, social, or natural aspiration levels) is associated with lower levels of subsequent strategic change. However, studies of performance often use reported accounting earnings as a measure of performance and there is reason to believe that managers actively manage reported earnings through accounting and operational choices (such as to smooth earnings). This study examines the relationship between earnings smoothing and strategic change and presents evidence suggesting that this relationship is not mediated through performance feedback and shortfalls below aspirational benchmarks.

Financial Statement Comparability, Earnings Smoothing and Loan-Loss Provisioning in Banking

We investigate the effect of financial statement comparability on banks’ earnings smoothing behavior through loan-loss provisioning. Financial statement comparability makes information about peers accessible to outside investors and, thereby, improves transparency and the information environment. We, therefore, predict a negative association between financial statement comparability and earnings smoothing for opportunistic reasons. Based on a sample of 628 US banks (4,683 bank-years observations) for the period 1999-2013, we show that financial statement comparability constrains income smoothing through loan-loss provisioning. We further reveal that this constraining effect is more pronounced for larger banks and during the global financial crisis (GFC) period. These results are robust to alternative specifications of comparability and earning management, bank (firm) fixed effect regression, and also dealing with endogeneity issues. We contribute to the literature on the benefits of producing comparable financial statements, as well as to the literature on the determinants of earnings smoothing by banks. Our results are also relevant for standard setters who stress the importance of financial statement comparability for nurturing investor confidence.

Doing Good When Doing Well: Evidence on Real Earnings Management

We provide evidence on earnings management by exploiting temporary exogenous shocks to utility firms’ sales in the form of annual weather variation. We find that sample firms’ sales are highly sensitive to annual changes in average temperatures in the region where the firm operates, but this sensitivity disappears quickly moving down the income statement. We interpret this as indirect evidence of earnings management. In search of direct evidence, we study charitable giving decisions by sample firms and uncover a significant positive sensitivity of charitable spending to weather-driven demand shocks. Given the magnitude of this detected relation and the economic returns from charitable giving, this behavior appears to be driven by a desire to smooth earnings.

Foreign Equity Ownership and Income Smoothing

We examine whether foreign investors influence a local firm’s income smoothing, using a sample of Korean firms from 2000 to 2013. We hypothesize that given innate informational difficulties of overseas investments, foreign investors demand less noisy and more sustainable earnings, and to satisfy this demand, managers have strong incentives to smooth earnings. We find that foreign investors’ ownership is positively related to the level of earnings smoothing. We also find that earnings smoothing improves earnings informativeness in the presence of high foreign-investor ownership, consistent with the notion that foreign investors play an important role in local firms’ information environments.

Foreign Equity Ownership and Income Smoothing

ABSTRACT We examine whether foreign investors influence a local firm's income smoothing, using a sample of Korean firms from 2000 to 2013. We hypothesize that given innate informational difficulties of overseas investments, foreign investors demand less noisy and more sustainable earnings, and to satisfy this demand, managers have strong incentives to smooth earnings. We find that foreign investors' ownership is positively related to the level of earnings smoothing. We also find that earnings smoothing improves earnings informativeness in the presence of high foreign investor ownership, consistent with the notion that foreign investors play an important role in local firms' information environments. JEL Classifications: M41; M43; J53.

Do bank managers use securitization gains to smooth earnings in the post- FAS 166/167 period?

Previous literature has documented that securitization gains were used for income smoothing in the era before FAS 166 and FAS 167,11FAS 166 and 167 have been codified by the FASB as parts of ASC 810-10 and 820-20, respectively. In this paper, we refer to the legacy standards to simplify exposition. which tightened the requirements for sale accounting for securitizations. Using securitizing bank holding companies, we examine whether FAS 166/167 has reduced this income smoothing behavior. Our findings include two facets. First, at the aggregate level, time series statistics show that both the frequency of non-zero securitization gains reported and the magnitude of reported securitization gains are significantly reduced in the post- FAS 166/167 period. Second, at the firm level, our regression results indicate that even though the extent of this income smoothing behavior decreased after the issuance of FAS 166/167, securitization gains continue to be used to smooth earnings by securitizing banks in the post-FAS 166/167 period. Overall, our findings convey that FAS 166/167 has reduced the securitization gains recorded by banks but that after the regulation, banks still use securitization gains to smooth earnings.

Do Banks Really Sell Securities to Smooth Earnings?

This study re-examines the ways that profitable banks manage earnings through the gain and loss selling of available-for-sale securities. We find that what the prior literature calls earnings smoothing is more accurately characterized as the boosting of low earnings; banks boost low earnings via gain selling but do not meaningfully reduce high earnings via loss selling or abnormally low gain selling. Although the earnings boosting behavior represents a statistical tendency over a wide sample period, the behavior is relatively uncommon even among low-earnings banks, except in the three years immediately following the financial crisis of 2008-2009, facilitated by the Federal Reserve’s crisis-era bond buying program. Previously unavailable data on gross gains and losses reveals that the portion of the unrealized gain positions that banks realize each quarter is about three times the portion of the unrealized loss positions realized, on average. When they do sell loss positions, banks tend to completely erase the impact on earnings by selling additional gain positions roughly dollar-for-dollar. Overall, results suggest that when accounting standards insulate earnings from unrealized changes in security fair values, the primary form of material earnings management that occurs among profitable banks is occasional gain-selling to boost low earnings.

Designing a Model for Examining the Relationship Between Earnings Quality and Stock Liquidity on the Stock Exchange

The present study was conducted to provide evidence to clarify the relationship between earnings quality and stock liquidity as well as assess the impact of earnings quality on stock liquidity. In this study, 96 companies listed in Tehran Stock Exchange during the 5-year period of 2011-201 as statistical population were surveyed. The independent variable in this study is earnings quality, which is measured by two indices (accruals quality and earnings smoothing). Stock Liquidity Measurement Two liquidity variables that are dependent variables are used: liquid float percentage, number of trading days, and control variable. Combined regression model and data were used to test the hypotheses. The results of sub tests showed that the accruals quality was inversely and significantly correlated with the percentage of free float stocks and the number of trading days; however, the results showed that profit smoothing was inversely and significantly correlated. It has a number of trading days, unless sufficient evidence is found to show a significant relationship between earnings smoothing and the percentage of free float stocks.

Asymmetric Cost Behaviour and Earnings Quality in the European Context

This study investigates the relationship of asymmetric cost behaviour with earnings quality for European listed firms. We employ a sample that consists of 11,416 firm-year observations of European listed firms over the period 2005-2019 to explore the relationship of asymmetric cost behaviour with (i) the managerial incentives to meet earnings targets, (ii) conditional conservatism, (iii) the level of operating accruals, and (iv) earnings smoothing. Our empirical evidence indicates that the presence of managerial incentives to meet earnings targets decreases the intensity of SG&A cost stickiness. We also document that asymmetric timeliness estimates in the conditional conservatism estimation models have an upward bias unless these models do not control for asymmetric cost behaviour. Finally, it seems that the levels of operating accruals and earnings smoothing are more sensitive to sales decreases than sales increases.

Human Resource Accounting and Quality of Financial Reporting of Quoted Oil and Gas Companies in Nigeria

Financial reporting is a veritable tool that provides information to all stakeholder’s for the purpose of decision making. The preparation and presentation of the report is done by the human asset. Building public confidence for capital market participants, transparency, and trust are very germane in any capital market. Poor earnings quality, opportunistic earnings and biased financial report portents great fears in the mind of investors and analysts alike in making rational investment decisions. The study investigated the effect of human resource accounting on quality of financial reporting (using earnings quality, accounting conservatism, earnings smoothness and persistence as proxies) of quoted oil and gas companies in Nigeria. The study adopted ex-post facto research design. The population of the study was 12 oil and gas companies in Nigeria. Purposive sampling technique was used and considered 12 oil and gas which had secondary data information that covered a period of 10 years from 2004 -2018. The null hypothesis (H0): Human Resource Accounting does not have significant effect on financial reporting quality in oil and gas companies in Nigeria The empirical findings of financial reporting quality revealed that the human asset provided the basis for these improvement in oil and gas companies with the results F(8.133)=65.13 (P – value=0.000); Adjusted R2=0.315 and F(5.102)=217.6 (P – Value=0.000); Adjusted R2=0.323. The study concluded that human resource accounting has significant effect on financial reporting quality of quoted oil and gas companies in Nigeria. The study recommended that the regulatory bodies should find ways of rewarding companies that comply with the regulatory guiding standards and comply with information disclosure for earnings quality assessment and sanction erring companies that conceal relevant and purposeful information from the stakeholders.

Customer Concentration and Income Smoothing Activities

We examine how customer concentration affects managers’ income smoothing incentives to signal their private information about risk and future earnings. We find a negative relation between customer concentration and income smoothing activities, indicating that improved information sharing from suppliers to customers through private channels reduces managers’ incentives to smooth earnings to provide private information about viability. To mitigate endogeneity issues, we perform three robustness tests: (1) a change in variables analysis, (2) a propensity score matching approach, and (3) a two-stage least squares regression analysis. We also show that the negative relation is more pronounced for supplier firms with larger relationship-specific investments for their major customers. Lastly, further analysis shows that managers’ income smoothing activities decrease as the length of the relationship between a supplier and its major customers increases, corroborating our main findings.

Managerial Ability, Financial Performance and Goodwill Impairment: A Moderated Mediation Analysis

This paper examines whether and how managerial ability affects the likelihood of goodwill impairment of Chinese publicly listed companies over the period 2007-2017. We document a negative relationship between goodwill impairment and managerial ability, and uncover the mediation effect of corporate financial performance. Moreover, we find that the mediation effect is moderated by firms’ earnings smoothing motivation and state ownership. The results suggest that when a company has the motivation to smooth earnings or is owned by the government, higher managerial ability of the company does not necessarily reduce the likelihood of goodwill impairment. The findings have important implications for investors and regulators.

대손충당금 분류조정을 이용한 상호저축은행의 이익관리; 특별대손충당금을 중심으로 (Earnings Management of Savings Banks Using Loan Assets Classification: Focusing on Special Loan Loss Provision)

Korean Abstract: 본 연구는 상호저축은행이 특별대손충당금의 분류조정을 이용하여 이익을 조정하는지를 살펴보았다. 상호저축은행은 일반(상업)은행과 달리 고정여신에 대한 충당금을 일부 자본으로 인정받는다. 상호저축은행이 위 규정을 이용하여, 특별대손충당금의 분류조정을 통해 이익관리 및 자본관리를 수행하는지 살펴보았다. 이를 검증하기 위하여 대손충당금 전입액을 일반대손충당금과 특별대손충당금으로 구분하고 대손충당금과 대손충당금 전입 및 법인세 전 이익과의 관련성을 살펴보았다. 실증분석결과 저축은행은 이익을 유연화하기 위하여 대출자산 항목의 분류조정을 이용하는 것으로 나타났다. 구체적으로, 상호저축은행은 고정이하여신 내 분류조정을 이용하여 특별대손충당금 전입액을 조정하여 이익을 유연화하고 있다. 재무건전성이 취약한(BIS 7% 미만) 저축은행의 경우에는 특별대손충당금 전입액을 이용한 이익조정을 더 많이 하는 것으로 나타났다. 이러한 결과는 저축은행의 고정여신의 충당금을 자본으로 인정하는 현행 제도의 수정보완이 필요함을 시사한다. English Abstract: This study examines earnings management method of savings banks which serve as representative financing institution for people with poor credit. Because regulatory and supervisory regulations of savings banks are different to those of commercial banks, managers of savings banks may reflect these characteristics in earnings management method. Especially, managers of the savings bank are expected to choose the earnings management method considering resulting costs and benefits such as effects on BIS ratio, discretion of loan assets classification, and the magnitude of earnings management. Empirical evidence indicates that savings bank discretionarily exploit classification of loans assets to smooth earnings. Specifically, managers discretionarily classify loan assets items upwards or downwards within non-performing assets. In addition, savings banks with BIS ratio lower than 7% tend to manage earnings upwards by classifying loan assets items upwards within non-performing assets to increase both net income and BIS ratio. The results of study imply that limitation of present regulatory and supervisory rules on savings banks incurs unintended negative effects on agency problem

Kualitas Akrual Memoderasi Earnings Opacity Terhadap Biaya Ekuitas

This study aims to examine the effect of earnings opacity on the cost of equity with accrual quality as a moderating variable. This studyuses two measures for earnings opacity which are earnings aggressiveness and earnings smoothing. Number of sampleis 40 manufacturing companies that distribute dividend periods 2015-2017. The method of analysis using interaction moderation regression.The results of this study showed that accrual quality strengthen the relationship between earnings aggressiveness and cost of equity. Accrual quality also weaken the relationship between earnings smoothing and cost of equity. Earnings aggressiveness has positive and significant effect on cost of equity. Earnings smoothing has positive but not significant effect on cost of equity.