Smooth Earnings Research Articles

Do Firms Smooth Earnings Less When They Can Hedge Noise Better?

ABSTRACT Firms’ use of accounting discretion to report a smooth earnings profile is commonly believed to be pervasive. We examine whether smoothing, at least partly, reflects managerial attempts to avert unhealthy pressures from outsiders who cannot fully disentangle the impact of transitory shocks from sustainable trends in value creation. Using variation in firms’ ability to hedge foreign currency (forex) exposure through derivatives, we find that firms are less likely to smooth earnings when they can better shield their business from extraneous forex fluctuations. Our findings inform the debate on discretion in accounting rules and illustrate how markets that facilitate efficient reallocation of risk can shape the informational properties of accounting output. JEL Classifications: F31; G32; M41.

The impact of the Board of Directors and the Audit Committee on the transparency of financial information of companies listed in a Frontier market

This study aims to evaluate the impact of factors representing the Board of Directors (BOD) and Audit Committee (AC) on financial information transparency (FIT) in a frontier market. FIT is measured through three indicators that reflect financial non-transparency: earnings aggressiveness (EA), earnings smoothing (ES) and loss avoidance (LA). Research data was collected from 338 companies listed on the Vietnam Stock Exchange (HOSE and HNX) from 2012 to 2022. The study uses the panel data analysis method through OLS, FEM, REM regression steps and necessary tests to select the appropriate analysis model. At the same time, model defects are handled by GLS and Robust regression. Our findings show that the factor representing BOD tends to increase the transparency of financial information, while the factor representing AC tends to decrease the transparency of financial information. This is the first study to examine the impact of composite factors representing BOD and AC and their component factors on FIT.

Co‐CEO Structure and Earnings Smoothing Incentives

AbstractThis paper investigates the effects of a co‐CEO structure on earnings smoothing and its implications for the informativeness of earnings. While the consequences of a co‐CEO structure have been relatively underexplored in prior research, existing studies suggest potential benefits, such as higher valuations and stronger internal governance. This paper delves into the specific consequences of a co‐CEO structure, focusing on earnings smoothing practices. Using data from Korean firms, where co‐CEO structures are prevalent, we find that firms with a co‐CEO structure exhibit smoother earnings compared to those with a sole‐CEO structure. However, the informativeness of these smooth earnings is reduced under a co‐CEO structure, suggesting that co‐CEOs engage in earnings smoothing primarily for their own benefit, rather than to provide more information to investors. Additional analyses reveal that co‐CEOs' earnings smoothing leads to adverse consequences for investors, including lower earnings quality, higher costs of capital, increased financial distress, greater credit risk, and higher stock price crash risk. Our study contributes to the literature by highlighting the potential costs associated with co‐CEO structures, particularly in terms of reduced earnings informativeness.

Risk disclosure, earnings smoothing and firm perceived risk

Purpose This paper aims to examine the association between perceived firm risk and two reporting mechanisms: risk disclosure and earnings smoothing in the UK context. Design/methodology/approach This study juxtaposes three competing views, the “null”, the “divergence” and the “convergence” hypotheses, and empirically investigates whether risk disclosure and earnings smoothing affect firm perceived risk for a sample of large UK firms with rich and poor information environments. This study also uses the global financial crisis as an external shock on overall risk in the economy to investigate when and how managers use these two reporting mechanisms to shape the firm perceived risk. Findings This paper documents that risk disclosures have no significant effect on investors’ risk perceptions, consistent with risk disclosures containing boilerplate and generic statements about firm risk. This paper also finds that earnings smoothing reduces investors’ risk perceptions, reflecting investors’ interpretations about future firm performance. Additional tests reveal that earnings smoothing is not associated with perceived firm risk for firms with rich information environments and expanded risk disclosures. Furthermore, reporting smooth earnings decreases perceived firm risk following the global financial crisis. These findings are robust to alternative specifications and measures of earnings smoothing as well as post-filing perceived firm risk. Research limitations/implications This study does not distinguish between the garbling role and the informational role of earnings smoothing. The risk disclosure measurement used in this study, developed based on UK annual reports, may limit the generalizability of findings to other countries. Practical implications The findings suggest that managers should revise their risk disclosure strategies to provide in-depth details on firm risk. Investors might require information and thorough assessment to evaluate investment risks when firms provide generic risk disclosures and smoothed earnings by consulting sources like financial intermediaries. Regulators should keep an eye on firms reporting boilerplate risk disclosures and on how smoothing earnings impacts the firm perceived risk following economic turmoil, to guide interventions that promote market stability. Originality/value The findings provide new insights into when and how managers use their financial reporting discretion to make firms appear less risky and, therefore, influence investors’ risk perceptions.

Taming the dragon: stock exchange comment letters and earnings volatility

This study explores the impact of comment letters on earnings volatility motivated by the broad scope of stock exchange comment letters in China and regulators’ concerns regarding earnings-related issues. Using a manually collected sample of Chinese comment letters, we find that receiving a comment letter is associated with increased earnings volatility. Our baseline results survive a host of exercises to mitigate endogeneity, including difference-in-differences, propensity score matching, entropy balancing, and instrumental variables. Channel analysis reveals that comment letters are associated with increased earnings volatility through dampened supply chain stability (economic channel) and reduced use of earnings management to smooth earnings (accounting channel). Our findings contribute to the literature on comment letters in non-US economies and provide important and timely implications for regulators.

Business strategy, earnings properties, and earnings quality

This study explores the relationship between business strategy and earnings properties, which are frequently considered as proxies of earnings quality. Specifically, we examine the implications of different strategic positionings for earnings properties that are related to earnings management, conditional conservatism, earnings persistence, and earnings smoothness. Using an international sample, our empirical results indicate that business strategy is inherently linked to these earnings properties. Firms that focus on a business strategy of continuous innovation have larger discretionary accruals, more persistent earnings, and lower earnings smoothness relative to firms that focus on a business strategy of operation efficiency. We also find some evidence for differences in conditional conservatism, although the associations are weaker and sensitive to sample composition. Our main inference is that business strategy inherently affects earnings properties.

Government subsidies and income smoothing

AbstractThis study examines the relationship between government subsidies and income smoothing using a sample of US‐listed firms. We find that subsidized firms smooth their earnings more aggressively than their unsubsidized peers. This finding is consistent with the reasoning that subsidized firms bear higher political costs and have more incentives to smooth earnings to avoid public attention. In addition, smoothing by subsidized firms is more pronounced when the subsidies are granted through non‐tax‐related channels than through tax‐based channels, and the positive association between government subsidies and income smoothing is stronger for firms under higher public scrutiny and with less transparent information environments. Further analysis shows that smoothing by subsidized firms serves mainly to obfuscate earnings and that subsidized firms that smooth earnings tend to continue receiving subsidies in the future. Overall, our results help explain the role of government subsidies in shaping firms' accounting and disclosure choices.

The Effect of Earnings Smoothing and Earnings Informativeness on Firm Value with Managerial Ability as a Moderating Variable

This study's goal is to find out how earnings informability and income smoothing affect firm value, with managerial ability as a moderating variable. A quantitative method was used, and financial statements that were listed on the Indonesia Stock Exchange served as the source of the data. The sample population comprised 255 companies within the Consumer Non-Cyclicals and Consumer Cyclicals sectors, with a 4-year study period from 2017 to 2020. In addition, a total of 154 companies were selected based on the inclusion criteria, and 616 observations were carried out. This study used data from an emerging market country, namely Indonesia, which was known as the most promising investment destination. The results showed that earnings smoothing did not affect firm value, while earnings informativeness had a significant effect. The relationship between income smoothing and firm value was unaffected by managerial skill, even though it increased the correlation between earning informativeness and firm value. In line with these findings, company leaders must choose managers with high skills in financial management. These skills can greatly influence the impact of earnings informativeness on firm value.

Does Ownership Structure and Financial Health Affect Firm’s Earnings Quality? Evidence from Emerging Economy

Earnings quality is a demanding attribute of firm and is valued by investors in resource allocation decisions. High earnings quality firms create value for stakeholders and poor earnings quality causes value deterioration. This study takes into account earnings quality attributes of Pakistani corporate sector and investigates impact of ownership structure and financial health on firms’ earnings quality. Earnings quality has been measured by four attributes of accrual quality, earnings persistence, earnings predictability, earnings smoothness. A sample of 325 non-financial PSX listed Firms have been selected and classified into four unique categories on the basis of financial health (healthy and distressed) and ownership (family and non-family). The classification aims to determine level of earnings quality for each category. Results find significant effect of book financial position and ownership structure on earnings quality of firms. Findings reveal Earnings quality for non distressed family (NDF) firms was highest followed by non distressed non family firms (NDNF), while earnings quality for distressed family (DF) firms was poor and poorer for distressed non family (DNF) firms when firms were classified into these four categories. These results provide important implications for investors, analysts, regulators and standard setters.

Dividen, Struktur Kepemilikan dan Tindakan Perataan Laba

Investors' desire towards the company's profit target encourages management to take income smoothing actions making an appearance that profits are stable, but in fact, profits are not as high as stated. Income smoothing can be affected by a number of variables, including dividend payout amounts and the ownership structure of a company. In order to examine the impact of dividend payments and ownership structure on income smoothing activities in non-financial companies, this study was carried out. The sample in this study comprised of 53 non-financial companies chosen using purposive sampling from the population of non-financial companies listed on the Indonesia Stock Exchange (IDX) from 2019 to 2021. The level of dividend payment had an impact on the income smoothing, according to the results of the logistic regression analysis that was used to test the hypothesis. The more dividends the company pays out, the more likely management will employ earnings smoothing. Companies typically flatten earnings to meet the amounts of dividends to be given to shareholders so that companies can continue to pay dividends to investors. This study informs shareholders on the company's practices for adjusting earnings to accommodate for dividend payments, enabling them to make more prudent portfolio decisions going forward. Keywords: Income smoothing, dividend, ownership structure.

Futures, provisional sales, and earnings management in the global gold mining industry

This study investigates the impact of futures on earnings management in the gold mining industry. Using quarterly data from a global sample of gold firms between 2003 and 2019, we find evidence of income-increasing accruals and real earnings management during contango periods (when futures price exceed the current spot price). Conversely, gold firms use income-decreasing accruals and real earnings management during backwardation periods (when the current spot price exceeds the futures price). This study contributes to the literature with evidence on futures as determinants of earnings management, as well as on the process through which managers smooth earnings.

Pengaruh Profitabilitas, Financial Leverage Dan Dividend Payout Ratio Terhadap Perataan Laba Pada Perusahaan Manufaktur Di BEI Periode 2019-2022

This research aims to determine the partial and simultaneous effects of profitability, financial leverage and dividend payout ratio on earnings smoothing. This type of research is classified as quantitative research. The population are manufacturing companies that focus on the basic and chemical industry sectors listed on the Indonesia Stock Exchange for the 2019-2022 period with a total of 91 companies. The purposive sampling method as a sampling was obtained as many as 72 companies. Using multiple linear regression analysis as analytical techniques assisted with SPSS version 25. The test results from the research show that partially the profitability (as measured by NPM) had no effect on income smoothing, financial leverage (as measured by DPR) had a negative and significant effect on income smoothing and the dividend payout ratio had a significant effect on income smoothing. While simultaneously the variables of profitability, financial leverage and dividend payout ratio have a significant effect on income smoothing.

The Effect of Language on Income Smoothing: Cross-Country Evidence

We examine whether and how the time-oriented tendency embedded in languages influences income smoothing. Separating languages into weak- versus strong-future time reference (FTR) groups, we find that firms in weak-FTR countries tend to smooth earnings more. We also find that relationships with major stakeholders (i.e., debtholders, suppliers, and employees) amplify the effect of the FTR of languages on income smoothing. Additional analyses suggest that income smoothing driven by the FTR of languages enhances earnings informativeness. These findings provide new insights on the role that language plays in financial reporting decisions and on how relationships with major stakeholders influence the relation between an important feature of language and corporate income smoothing behavior. This paper was accepted by Brian Bushee, accounting. Funding: L. A. Myers acknowledges financial support from the University of Tennessee [the Haslam Chair of Business and the Haslam Family Faculty Research Fellowship]. Supplemental Material: The data files and online appendix are available at https://doi.org/10.1287/mnsc.2021.01753 .

Female Director, CEO Compensation, and Earnings Smoothing

This paper is the first one in the literature to examine the effect of female directors on earnings smoothing and the potential channels through which such an effect may occur. When the interaction of female directors and CEO incentive compensation is not included, there is no significant overall effect of female directors on earnings smoothing. However, when the interaction term is added, the presence of female directors shows a strengthening effect in significantly increasing the association between incentive compensation and earnings smoothing. Further, the presence of female directors itself appears to play a moderating role in reducing the incidence of earnings smoothing, which conflicts with the effect of female directors through incentive compensation. The conflicting effects exist among both female directors in general and independent female directors. The complex effects of female directors have direct implications for corporate governance policies.

Income smoothing through R&D management and credit ratings

Purpose Prior studies generally focus on income smoothing through discretionary accruals and document that managers have incentives to smooth earnings due to various reasons. This paper aims to focus on income smoothing through research and development (R&D) management and examine whether and how income smoothing through R&D management affects credit rating agencies’ perception of firm risk. Design/methodology/approach The authors use financial statement data from the CRSP/Compustat Merged data set universe for the period from 1992 to 2019 after excluding financial and utility industries. The authors follow the model for credit ratings used in previous literature to test the hypothesis. Specifically, the authors use an ordered probit model to express credit ratings as a function of income smoothing attributes. Findings The authors find that R&D-based income smoothing improves a firm’s credit rating. However, the positive effect of R&D-based income smoothing on credit ratings is less than that of accruals-based income smoothing. This study also shows that the positive effect of R&D-based income smoothing is more pronounced for firms less subject to opportunistic incentives, further strengthening the notion that managers smooth earnings through R&D management to provide more informative earnings. Originality/value This study contributes to the income smoothing literature in several ways. First, the authors contribute to the research by showing that managers’ income smoothing activity through R&D management positively affects firms’ credit rating. Second, the authors also document the relative benefits of the two different income smoothing techniques in terms of improving credit agencies’ perception of firms’ creditworthiness.

Bank capital, earnings smoothing and provisioning practices in Nigeria: IFRS and risk evidence

PurposeThis study empirically tests the use of loan loss provisions (LLPs) for earnings and capital smoothing when emphasis is laid on banks' riskiness and adoption of the International Financial Reporting Standards (IFRSs) in Nigeria.Design/methodology/approachAnnual bank-level data are hand-extracted between 2007 and 2017 from annual reports of a sample 16 deposit money banks (DMBs), and analysed using appropriate panel regression models subsequent to a number of diagnostic tests including heteroscedasticity, autocorrelation and cross-sectional dependence. The use of both reported LLPs (TLLP) and discretionary LLPs (DLLP) for earnings and capital management is tested to advance the practice in the literature.FindingsGenerally, the study finds that Nigerian DMBs manage capital via LLPs, while mixed results are obtained for earnings smoothing. However, during IFRS, Nigerian DMBs' management of capital is identifiable with TLLP, while smoothing of earnings is peculiar to DLLP. Additionally, evidence of the improvement in loan loss reporting quality expected during IFRS for riskier Nigerian DMBs, could not be attained. This is corroborated by the study's findings of the use of both TLLP and DLLP for earnings and capital management during IFRS by DMBs in solvency crisis against the only use of TLLP to manage capital found for the entire period.Practical implicationsThe evidential capital and earnings lopsidedness may subject Nigerian DMBs' going-concern to a lot of questions.Originality/valueThe study sets a foremost record in the empirical test of managerial opportunistic behaviour embedded in earnings and capital concurrently while accounting for loan losses by all categories of Nigerian DMBs in terms of riskiness, following accounting regime change.

Reporting comprehensive income and firms' earnings management

This study investigates the impact of reporting comprehensive income and other income through performance or equity statements on firms' earnings management through the selective sale of available-for-sale (AFS) securities. The objective is to explore how Canadian firms can improve transparency by altering managers' accounting behavior by switching from equity statements to income statements. The study used a difference-in-differences method in a quasi-experimental framework. The results showed that negative net income and post-period net income in performance statements can reduce realized gains and losses. Available-for-sale securities also affect these gains and losses in performance and equity statements. Single statement adopters only smooth earnings when net income is positive or when available-for-sale gains are large enough to offset negative earnings. Income statement (IS) adopters reduced earnings smoothing more than other treatment firms. Managers with less job security were found to be more likely to engage in earnings smoothing, and earnings smoothing decreased more during the pre-to-post period. Equity incentives reduced the tendency to smooth earnings, particularly in treatment firms with CEOs whose pay is more sensitive to stock price changes. Treatment firms outperform control firms in predicting future earnings using realized gains and losses on AFS securities per share. The findings suggest that firms manage earnings less effectively by selectively selling AFS securities when comprehensive income (CI) or other comprehensive income (OCI) is presented in performance statements. Firms win when earnings management is reduced because it reduces the informativeness of realized gains and losses on AFS securities. Managers will use more earnings management strategies as long as they have incentives.

IFRS Mandatory Adoption and Earnings Quality in an Emerging Market: The Case of Ecuador

This paper examines changes in earnings quality, including accruals, earnings smoothing, and asymmetric loss recognition schedules, following the mandatory adoption of IFRS in Ecuador. Using 5,436 year-firm observations, we employ a differences-in-differences approach, comparing the effect of IFRS on an initial group of adopters (publicly traded companies) with non-adopters (small and medium-sized enterprises) with essentially the same financial reporting requirements. Our findings indicate a decrease in accrual levels and more timely recognition of losses, with no evidence of changes in earnings smoothing. These results suggest that companies use the increased flexibility of IFRS to meet debt holders' demand for timely loss recognition. The decrease in accruals suggests earnings management for tax purposes. This study contributes to the literature on IFRS and earnings quality by using a more robust research design and providing evidence on the consequences of IFRS adoption in an emerging market dominated by debt capital and family-owned firms.

The effects of boardroom gender diversity and audit quality on financial earnings smoothing in GCC countries: Do government board members moderate the relationship?

This study explores the effects of boardroom gender and audit quality on financial earnings smoothing (FES) in the Gulf Cooperation Council (GCC) countries. Additionally, the moderating effects of government representatives as board members on FES are investigated. The study covers six GCC countries: Saudi Arabia, the UAE, Oman, Bahrain, Kuwait, and Qatar. The sample comprises 188 firms from 2013 to 2019. Multiple regression models are used to evaluate the study’s hypotheses. The findings show that the big international and local firms that have both female and male board members, as well as government representatives, on their boards demonstrate effective governance mechanisms. Although they had a negative impact on higher FES, they had a positive impact on lower FES. As for the moderating role, the findings reveal that the role of government members on the board is complementary to the audit quality, particularly in the big four international and local firms. This research may aid businesses in implementing the best governance practices to avoid FES and improve the quality of accounting data, in line with the objectives of the government. However, good practices in moderating earnings smoothing were mainly seen amongst the males.

ENTERPRISE RISK MANAGEMENT DAN KUALITAS LABA: PERAN DARI KOMPETENSI AUDIT INTERNAL

Abstract - There is debate whether ERM can improve the quality of financial reporting information or not. This study aims to examine the effect of the level of ERM disclosure on the quality of company earnings which is then moderated by internal audit competence. The sample of this study are companies listed on the Indonesia Stock Exchange during 2019 except for financial sector companies. The results of this study show that the level of ERM disclosure has no effect on earnings predictability, earnings smoothing, and earnings volatility. In addition, internal audit competency moderation does not affect the relationship between the level of ERM implementation and earnings quality as measured by earnings predictability, earnings smoothing, and earnings volatility. The implication of this research is that stricter policies will encourage companies to implement ERM better. Future research can test the level of ERM implementation using a case study approach.
 Keywords: Enterprise Risk Management; Implementasi ERM; Kualitas Laba; Earnings Predictability; Earnings Smoothing; Earnings Volatility; Kompetensi Audit Internal.