Societal Trust and Income Smoothing

This paper investigates the effect of societal trust on information communication between managers and outside investors, focusing on income smoothing as a communication channel. Using a large cross‐country sample, we find that firms in more trusting countries are less likely to use income smoothing to signal their private information (‘informational smoothing’). This finding suggests that societal trust attenuates investors’ concern of moral hazard and diminishes their demand for firms’ private information, while managers respond to this change in information demand by reducing the extent of informational smoothing. We also find that the negative impact of societal trust on informational smoothing is less pronounced in countries with stronger formal institutions, indicating that trust serves as a substitute for formal institutions. Overall, this study enhances our understanding of the different impacts of societal trust on various forms of information communication tools and the variations in the informational aspects of income smoothing practices worldwide. Using cross‐country data, we find that firms in more trusting countries rely less on informational income smoothing. This suggests that societal trust reduces investors' moral hazard concerns and demand for private information, prompting managers to decrease informational smoothing. Overall, this study enhances our understanding of the variations in the informational aspects of income smoothing practices worldwide.