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Do artificial income smoothing and real income smoothing contribute to firm value equivalently?

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  • Huang, Pinghsun
  • Zhang, Yan
  • Deis, Donald R.
  • Moffitt, Jacquelyn S.
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    Abstract

    This paper examines the potential impacts of artificial smoothing (abnormal accruals) and real smoothing (derivatives) on firm value. We find that the value of the firm decreases with the magnitude of abnormal accruals and increases with the level of derivative use. Moreover, the accrual discount is more pronounced in firms with weak investor protection and the hedging premium is greater for poorly governed firms. These results suggest that although managers can engage in real smoothing to improve the informativeness of firms' earnings and thus reduce agency costs, they might use artificial techniques to cosmetically improve the income stream in order to expropriate minority shareholders. In further support of agency theories, we report that poor corporate governance motivates the use of abnormal accruals and discourages derivative use.

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    Bibliographic Info

    Article provided by Elsevier in its journal Journal of Banking & Finance.

    Volume (Year): 33 (2009)
    Issue (Month): 2 (February)
    Pages: 224-233

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    Handle: RePEc:eee:jbfina:v:33:y:2009:i:2:p:224-233

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    Web page: http://www.elsevier.com/locate/jbf

    Related research

    Keywords: Abnormal accruals Corporate governance Derivatives Income smoothing;

    References

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    1. David Aboody & John Hughes & Jing Liu, 2005. "Earnings Quality, Insider Trading, and Cost of Capital," Journal of Accounting Research, Wiley Blackwell, vol. 43(5), pages 651-673, December.
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    3. DeMarzo, Peter M & Duffie, Darrell, 1995. "Corporate Incentives for Hedging and Hedge Accounting," Review of Financial Studies, Society for Financial Studies, vol. 8(3), pages 743-71.
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    15. Mitchell A. Petersen & S. Ramu Thiagarajan, 2000. "Risk Measurement and Hedging: With and Without Derivatives," Financial Management, Financial Management Association, vol. 29(4), Winter.
    16. Anand Mohan Goel & Anjan V. Thakor, 2004. "Why Do Firms Smooth Earnings?," Finance 0411021, EconWPA.
    17. Kothari, S.P. & Leone, Andrew J. & Wasley, Charles E., 2005. "Performance matched discretionary accrual measures," Journal of Accounting and Economics, Elsevier, vol. 39(1), pages 163-197, February.
    18. Allayannis, George & Weston, James P, 2001. "The Use of Foreign Currency Derivatives and Firm Market Value," Review of Financial Studies, Society for Financial Studies, vol. 14(1), pages 243-76.
    19. Konan Chan & Louis K. C. Chan & Narasimhan Jegadeesh & Josef Lakonishok, 2006. "Earnings Quality and Stock Returns," The Journal of Business, University of Chicago Press, vol. 79(3), pages 1041-1082, May.
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    Cited by:
    1. Chi, Jianxin (Daniel) & Gupta, Manu, 2009. "Overvaluation and earnings management," Journal of Banking & Finance, Elsevier, vol. 33(9), pages 1652-1663, September.

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