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What Do Smoothed Earnings Tell Us about the Future?

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Author Info

  • Yusuke Takasu

    (Graduate School of Commerce and Management, Hitotsubashi University, Japan)

  • Makoto Nakano

    (Graduate School of Commerce and Management, Hitotsubashi University, Japan)

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    Abstract

    This study analyzes the information contents of income smoothing behavior, especially the role of income smoothing behavior as a signal of future performance. What do smoothed earnings tell us about the future? To answer this research question, this paper focuses on earnings persistence and dividend policy based on two prior survey papers. These two issues (earnings persistence and dividend policy) are the foci of this study, based on Japanese managers’ responses to questions regarding their motivation for income smoothing. This paper provides two new pieces of evidence. First, income smoothing in the previous period relates positively to future earnings persistence. Second, firms that engage in more smoothing tend to pay more stable dividends in the future, even when we control for past dividend policy, fundamental factors, and corporate governance factors. These results indicate that income smoothing behavior is likely to reflect future stability of earnings performance. Income smoothing acts as a vehicle through which managers can reveal private information about future earnings persistence and future dividend policy. The empirical evidence supports the information view rather than a garbling view of income smoothing, and sheds light on the bright side of smoothed earnings rather than its dark side.

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    File URL: http://www.rieb.kobe-u.ac.jp/tjar/article/vol2/pdf/1.Takasu_and_Nakano.pdf
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    Bibliographic Info

    Article provided by Research Institute for Economics & Business Administration, Kobe University in its journal The Japanese Accounting Review.

    Volume (Year): 2 (2012)
    Issue (Month): (December)
    Pages: 1-32

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    Handle: RePEc:kob:tjrevi:dec2012:v:2:p:1-32

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    Related research

    Keywords: Income Smoothing; Private Information; Earnings Persistence; Dividend Policy;

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    References

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    1. Don Herrmann & Tatsuo Inoue & Wayne B. Thomas, 2003. "The Sale of Assets to Manage Earnings in Japan," Journal of Accounting Research, Wiley Blackwell, vol. 41(1), pages 89-108, 03.
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    11. Denis, David J. & Osobov, Igor, 2008. "Why do firms pay dividends? International evidence on the determinants of dividend policy," Journal of Financial Economics, Elsevier, vol. 89(1), pages 62-82, July.
    12. Akinobu Shuto & Takuya Iwasaki, 2011. "Stable shareholdings, the decision horizon problem, and patterns of earnings management," Discussion Paper Series DP2011-18, Research Institute for Economics & Business Administration, Kobe University, revised May 2012.
    13. Dichev, Ilia D. & Tang, Vicki Wei, 2009. "Earnings volatility and earnings predictability," Journal of Accounting and Economics, Elsevier, vol. 47(1-2), pages 160-181, March.
    14. Leuz, Christian & Nanda, Dhananjay & Wysocki, Peter D., 2003. "Earnings management and investor protection: an international comparison," Journal of Financial Economics, Elsevier, vol. 69(3), pages 505-527, September.
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