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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.

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.

Suggested Citation

  • Huang, Pinghsun & Zhang, Yan & Deis, Donald R. & Moffitt, Jacquelyn S., 2009. "Do artificial income smoothing and real income smoothing contribute to firm value equivalently?," Journal of Banking & Finance, Elsevier, vol. 33(2), pages 224-233, February.
  • Handle: RePEc:eee:jbfina:v:33:y:2009:i:2:p:224-233
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    References listed on IDEAS

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    Cited by:

    1. Iatridis, George Emmanuel, 2016. "Financial reporting language in financial statements: Does pessimism restrict the potential for managerial opportunism?," International Review of Financial Analysis, Elsevier, vol. 45(C), pages 1-17.
    2. Chi, Jianxin (Daniel) & Gupta, Manu, 2009. "Overvaluation and earnings management," Journal of Banking & Finance, Elsevier, vol. 33(9), pages 1652-1663, September.
    3. Chia-Ling Chao & Shwu-Min Horng, 2013. "Asset write-offs discretion and accruals management in Taiwan: the role of corporate governance," Review of Quantitative Finance and Accounting, Springer, vol. 40(1), pages 41-74, January.
    4. Iatridis, George Emmanuel, 2015. "Corporate philanthropy in the US stock market: Evidence on corporate governance, value relevance and earnings manipulation," International Review of Financial Analysis, Elsevier, vol. 39(C), pages 113-126.
    5. Ken Cyree & Pinghsun Huang & James Lindley, 2012. "The Economic Consequences of Banks’ Derivatives Use in Good Times and Bad Times," Journal of Financial Services Research, Springer;Western Finance Association, vol. 41(3), pages 121-144, June.
    6. Haggard, K. Stephen & Howe, John S. & Lynch, Andrew A., 2015. "Do baths muddy the waters or clear the air?," Journal of Accounting and Economics, Elsevier, vol. 59(1), pages 105-117.

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