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Earnings smoothing: Does it exacerbate or constrain stock price crash risk?

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  • Chen, Changling
  • Kim, Jeong-Bon
  • Yao, Li

Abstract

We examine the relation between earnings smoothing and stock price crash risk to evaluate the role of earnings smoothing on the downside risk of equity values. We find that, within firm, a higher degree of earnings smoothing is associated with greater crash risk; and this association, in the cross-section, is more pronounced for firms with fewer analysts following, smaller institutional holdings, and positive cumulative discretionary accruals. We also use stock returns to assess the economic significance of our results. We find that, controlling for firm fixed effects, earnings smoothing is associated with sizable negative returns in the quarter following the earnings announcement. Our findings caution investors about the downside risk of firms reporting smooth earnings, in contrast to the conventional belief that these firms are low in equity risk.

Suggested Citation

  • Chen, Changling & Kim, Jeong-Bon & Yao, Li, 2017. "Earnings smoothing: Does it exacerbate or constrain stock price crash risk?," Journal of Corporate Finance, Elsevier, vol. 42(C), pages 36-54.
    • Handle: RePEc:eee:corfin:v:42:y:2017:i:c:p:36-54
    DOI: 10.1016/j.jcorpfin.2016.11.004
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    More about this item

    Keywords

    Stock price crash risk; Earnings smoothing; Managerial opportunism; Private information signalling; External monitoring;
    All these keywords.

    JEL classification:

    • G12 - Financial Economics - - General Financial Markets - - - Asset Pricing; Trading Volume; Bond Interest Rates
    • G14 - Financial Economics - - General Financial Markets - - - Information and Market Efficiency; Event Studies; Insider Trading
    • M41 - Business Administration and Business Economics; Marketing; Accounting; Personnel Economics - - Accounting - - - Accounting

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