Advertisement

Smoothing and Earnings Management Policies

  • Domitilla MagniEmail author
Chapter

Abstract

This chapter lays the first bases on the concept smoothing. This latter topic is inserted in a broader context that is those of earnings quality management. Moreover, this chapter explains the real earnings management policies such as income smoothing, big bath earnings management, and income minimization and income maximization policies.

An earnings management strategy that has survived the test of time is smoothing. Smoothing is the dampening of fluctuations in the series of reported earnings.

This chapter tries to understand the motivations to smooth along the two dimensions of capital markets and governance. The capital market-oriented motivation centers on the informational value of smoothing and the demand for consumption smoothing. The governance motivation centers on the smoothing incentives of an agent in multiperiod principal–agent relationships.

Keywords

Smoothing Banking system Earnings management Reporting Earning quality Income Financial statement 

References

  1. Ahmed, A. S., Zhou, J., & Lobo, G. J. (2006). Job security and income smoothing: An empirical test of the Fudenberg and Tirole (1995) model. Available at SSRN 248288.Google Scholar
  2. Allen, D. W., & Lueck, D. (1995). Risk preferences and the economics of contracts. The American Economic Review, 85(2), 447–451.Google Scholar
  3. Arya, A., Glover, J., & Sunder, S. (1998). Earnings management and the revelation principle. Review of Accounting Studies, 3(1–2), 7–34.CrossRefGoogle Scholar
  4. Bannister, J. W., & Newman, H. A. (1996). Accrual usage to manage earnings toward financial analysts’ forecasts. Review of Quantitative Finance and Accounting, 7(3), 259–278.CrossRefGoogle Scholar
  5. Barth, M. E., Elliott, J. A., & Finn, M. W. (1999). Market rewards associated with patterns of increasing earnings. Journal of Accounting Research, 37(2), 387–413.CrossRefGoogle Scholar
  6. Belkaoui, A., & Picur, R. D. (1984). The smoothing of income numbers: Some empirical evidence on systematic differences between core and periphery industrial sectors. Journal of Business Finance & Accounting, 11(4), 527–545.CrossRefGoogle Scholar
  7. Beuselinck, C., & Deloof, M. (2014). Earnings management in business groups: Tax incentives or expropriation concealment? The International Journal of Accounting, 49(1), 27–52.CrossRefGoogle Scholar
  8. Bitner, L. N., & Dolan, R. C. (1996). Assessing the relationship between income smoothing and the value of the firm. Quarterly Journal of Business and Economics, 35, 16–35.Google Scholar
  9. Booth, G. G., Kallunki, J. P., & Martikainen, T. (1996). Post-announcement drift and income smoothing: Finnish evidence. Journal of Business Finance & Accounting, 23(8), 1197–1211.CrossRefGoogle Scholar
  10. Boylan, R. T., & Villadsen, B. (1998). Contracting and income smoothing in an infinite agency model. Washington University, Olin Working Paper Series OLIN-97-16.Google Scholar
  11. Buckmaster, D. A. (2001). Development of the income smoothing literature, 1893–1998: A focus on the United States (Vol. 4). Amsterdam: Elsevier.Google Scholar
  12. Burgstahler, D., & Dichev, I. (1997). Earnings management to avoid earnings decreases and losses. Journal of Accounting and Economics, 24(1), 99–126.CrossRefGoogle Scholar
  13. Carlson, S. J., & Bathala, C. T. (1997). Ownership differences and firms’ income smoothing behavior. Journal of Business Finance & Accounting, 24(2), 179–196.CrossRefGoogle Scholar
  14. Chaney, P. K., & Lewis, C. M. (1995). Earnings management and firm valuation under asymmetric information. Journal of Corporate Finance, 1(3–4), 319–345.CrossRefGoogle Scholar
  15. Chaney, P. K., & Lewis, C. M. (1998). Income smoothing and underperformance in initial public offerings. Journal of Corporate Finance, 4(1), 1–29.CrossRefGoogle Scholar
  16. Cheng, Q., & Warfield, T. D. (2005). Equity incentives and earnings management. The Accounting Review, 80(2), 441–476.CrossRefGoogle Scholar
  17. Christensen, P. O., & Feltham, G. A. (1993). Communication in multiperiod agencies with production and financial decisions. Contemporary Accounting Research, 9(2), 706–744.CrossRefGoogle Scholar
  18. Christensen, P. O., Feltham, G. A., & Şabac, F. (2005). A contracting perspective on earnings quality. Journal of Accounting and Economics, 39(2), 265–294.CrossRefGoogle Scholar
  19. DeFond, M. L., & Park, C. W. (1997). Smoothing income in anticipation of future earnings. Journal of Accounting and Economics, 23(2), 115–139.CrossRefGoogle Scholar
  20. Degeorge, F., Patel, J., & Zeckhauser, R. (1999). Earnings management to exceed thresholds. The Journal of Business, 72(1), 1–33.CrossRefGoogle Scholar
  21. Demski, J. S. (1998). Performance measure manipulation. Contemporary Accounting Research, 15(3), 261–285.CrossRefGoogle Scholar
  22. Dye, R. A. (1988). Earnings management in an overlapping generations model. Journal of Accounting Research, 26, 195–235.CrossRefGoogle Scholar
  23. Eckel, N. (1981). The income smoothing hypothesis revisited. Abacus, 17(1), 28–40.CrossRefGoogle Scholar
  24. Elgers, P. T., Pfeiffer, R. J., Jr, & Porter, S. L. (2000). Anticipatory smoothing: A reexamination. Working Paper, University of Massachusetts.Google Scholar
  25. Elitzur, R. R., & Yaari, V. (1995). Executive incentive compensation and earnings manipulation in a multi-period setting. Journal of Economic Behavior & Organization, 26(2), 201–219.CrossRefGoogle Scholar
  26. Ewert, R., & Wagenhofer, A. (2005). Economic effects of tightening accounting standards to restrict earnings management. The Accounting Review, 80(4), 1101–1124.CrossRefGoogle Scholar
  27. Fellingham, J. C., Newman, D. P., & Suh, Y. S. (1985). Contracts without memory in multiperiod agency models. Journal of Economic Theory, 37(2), 340–355.CrossRefGoogle Scholar
  28. Francis, J., Hanna, J. D., & Vincent, L. (1996). Causes and effects of discretionary asset write-offs. Journal of Accounting Research, 34, 117–134.CrossRefGoogle Scholar
  29. Fudenberg, D., & Tirole, J. (1995). A theory of income and dividend smoothing based on incumbency rents. Journal of Political Economy, 103(1), 75–93.CrossRefGoogle Scholar
  30. Fudenberg, D., Holmstrom, B., & Milgrom, P. (1990). Short-term contracts and long-term agency relationships. Journal of Economic Theory, 51(1), 1–31.CrossRefGoogle Scholar
  31. Godfrey, J. M., & Jones, K. L. (1999). Political cost influences on income smoothing via extraordinary item classification. Accounting & Finance, 39(3), 229–253.CrossRefGoogle Scholar
  32. Goel, A. M., & Thakor, A. V. (2003). Why do firms smooth earnings? The Journal of Business, 76(1), 151–192.CrossRefGoogle Scholar
  33. Graham, J. R., Harvey, C. R., & Rajgopal, S. (2005). The economic implications of corporate financial reporting. Journal of Accounting and Economics, 40(1–3), 3–73.CrossRefGoogle Scholar
  34. Hallock, K. F., & Oyer, P. (1999). The timeliness of performance information in determining executive compensation. Journal of Corporate Finance, 5(4), 303–321.CrossRefGoogle Scholar
  35. Hann, R. N., Lu, Y. Y., & Subramanyam, K. R. (2007). Uniformity versus flexibility: Evidence from pricing of the pension obligation. The Accounting Review, 82(1), 107–137.CrossRefGoogle Scholar
  36. Healy, P. M. (1985). The effect of bonus schemes on accounting decisions. Journal of Accounting and Economics, 7(1–3), 85–107.CrossRefGoogle Scholar
  37. Holmstrom, B., & Milgrom, P. (1987). Aggregation and linearity in the provision of intertemporal incentives. Econometrica: Journal of the Econometric Society, 55, 303–328.CrossRefGoogle Scholar
  38. Hoogendoorn, M. N. (1985). Income smoothing. Rotterdam: Erasmus University.Google Scholar
  39. Hunt, A., Moyer, S. E., & Shevlin, T. (1996). Managing interacting accounting measures to meet multiple objectives: A study of LIFO firms. Journal of Accounting and Economics, 21(3), 339–374.CrossRefGoogle Scholar
  40. Kanagaretnam, K., Lobo, G. J., & Yang, D. H. (2004). Joint tests of signaling and income smoothing through bank loan loss provisions. Contemporary Accounting Research, 21(4), 843–884.CrossRefGoogle Scholar
  41. Kirschenheiter, M., & Melumad, N. D. (2002). Can “big bath” and earnings smoothing co-exist as equilibrium financial reporting strategies? Journal of Accounting Research, 40(3), 761–796.CrossRefGoogle Scholar
  42. Lambert, R. A. (1984). Income smoothing as rational equilibrium behavior. Accounting Review, 59, 604–618.Google Scholar
  43. Malcomson, J. M., & Spinnewyn, F. (1988). The multiperiod principal-agent problem. The Review of Economic Studies, 55(3), 391–407.CrossRefGoogle Scholar
  44. Mohanram, P. S. (2003). How to manage earnings management. Accounting World, 10(1), 1–12.Google Scholar
  45. Monsen, R. J., Jr., & Downs, A. (1965). A theory of large managerial firms. Journal of Political Economy, 73(3), 221–236.CrossRefGoogle Scholar
  46. Moses, O. D. (1987). Income smoothing and incentives: Empirical tests using accounting changes. Accounting Review, 62, 358–377.Google Scholar
  47. Myers, J. N., Myers, L. A., & Skinner, D. J. (2007). Earnings momentum and earnings management. Journal of Accounting, Auditing & Finance, 22(2), 249–284.CrossRefGoogle Scholar
  48. Oyer, P. (1998). Fiscal year ends and nonlinear incentive contracts: The effect on business seasonality. The Quarterly Journal of Economics, 113(1), 149–185.CrossRefGoogle Scholar
  49. Payne, J. L., & Robb, S. W. (2000). Earnings management: The effect of ex ante earnings expectations. Journal of Accounting, Auditing & Finance, 15(4), 371–392.CrossRefGoogle Scholar
  50. Rogerson, W. P. (1985). The first-order approach to principal-agent problems. Econometrica: Journal of the Econometric Society, 53, 1357–1367.CrossRefGoogle Scholar
  51. Ronen, J., & Sadan, S. (1981). Smoothing income numbers: Objectives, means, and implications. Reading: Addison-Wesley Publishing Company.Google Scholar
  52. Ronen, J., & Yaari, V. (2008). Earnings management (Vol. 372). New York: Springer US.Google Scholar
  53. Ronen, J., Sadan, S., & Snow, C. (1977). Income smoothing: A review. Accounting Journal, 11, 26.Google Scholar
  54. Roychowdhury, S. (2006). Earnings management through real activities manipulation. Journal of Accounting and Economics, 42(3), 335–370.CrossRefGoogle Scholar
  55. Sankar, M. R., & Subramanyam, K. R. (2001). Reporting discretion and private information communication through earnings. Journal of Accounting Research, 39(2), 365–386.CrossRefGoogle Scholar
  56. Saudagaran, S. M., & Sepe, J. F. (1996). Replication of moses’ income smoothing tests with Canadian and UK data: A note. Journal of Business Finance & Accounting, 23(8), 1219–1222.CrossRefGoogle Scholar
  57. Schipper, K. (1989). Earnings management. Accounting Horizons, 3(4), 91.Google Scholar
  58. Sivaramakrishnan, K. (1994). Information asymmetry, participation, and long-term contracts. Management Science, 40(10), 1228–1244.CrossRefGoogle Scholar
  59. Spear, S. E., & Srivastava, S. (1987). On repeated moral hazard with discounting. The Review of Economic Studies, 54(4), 599–617.CrossRefGoogle Scholar
  60. Srinidhi, B., Ronen, J., & Maindiratta, A. (2001). Market imperfections as the cause of accounting income smoothing—The case of differential capital access. Review of Quantitative Finance and Accounting, 17(3), 283–300.CrossRefGoogle Scholar
  61. Stein, J. C. (1988). Takeover threats and managerial myopia. Journal of Political Economy, 96(1), 61–80.CrossRefGoogle Scholar
  62. Subramanyam, K. R. (1996). The pricing of discretionary accruals. Journal of Accounting and Economics, 22(1–3), 249–281.CrossRefGoogle Scholar
  63. Suh, Y. S. (1990). Communication and income smoothing through accounting method choice. Management Science, 36(6), 704–723.CrossRefGoogle Scholar
  64. Tan, H. C., & Jamal, K. (2006). Effect of accounting discretion on ability of managers to smooth earnings. Journal of Accounting and Public Policy, 25(5), 554–573.CrossRefGoogle Scholar
  65. Tokuga, Y. T. Y., & Yamashita, T. Y. T. (2011). Big bath and management change. Working paper available at https://www.econ.kyoto-u.ac.jp
  66. Townsend, R. M. (1982). Optimal multiperiod contracts and the gain from enduring relationships under private information. Journal of Political Economy, 90(6), 1166–1186.CrossRefGoogle Scholar
  67. Trueman, B., & Titman, S. (1988). An explanation for accounting income smoothing. Journal of Accounting Research, 26, 127–139.CrossRefGoogle Scholar
  68. Tucker, J. W., & Zarowin, P. A. (2006). Does income smoothing improve earnings informativeness? The Accounting Review, 81(1), 251–270.CrossRefGoogle Scholar
  69. Verrecchia, R. E. (1986). Managerial discretion in the choice among financial reporting alternatives. Journal of Accounting and Economics, 8(3), 175–195.CrossRefGoogle Scholar
  70. Verriest, A., & Gaeremynck, A. (2009). What determines goodwill impairment. Review of Business and Economics, 54(2), 1–31.Google Scholar
  71. Yaari, V. (2005). Smoothing, conservative smoothing, and truth-telling: The effect of the pressure to report target earnings on the earnings management strategy and the likelihood of a restatement. Working paper, Morgan State University.Google Scholar

Copyright information

© The Author(s) 2019

Authors and Affiliations

  1. 1.Roma Tre UniversityRomaItaly

Personalised recommendations