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Article

Mahdi Salehi and Nazanin Bashiri Manesh

The purpose of this paper is to investigate whether income smoothing does indeed improve the informativeness of stock prices about firms' future earnings and cash flows…

Abstract

Purpose

The purpose of this paper is to investigate whether income smoothing does indeed improve the informativeness of stock prices about firms' future earnings and cash flows. Also an approach to studying the effects of income smoothing is presented.

Design/methodology/approach

This study uses data from 1992‐2006 and runs regressions on each of the 560 industry‐year cross‐sections. The data compiled from the financial statements of firms were collected for each year available from the Tehran Stock Exchange database. Income smoothing is defined as the management of accruals to reduce time‐series variation in income, and uses a cross‐sectional version of the Jones model, modified by Kothari, Leone and Wasley. Smoothing is measured as the variation of net income relative to the variation in CFO, or the correlation between changes in accruals and changes in CFO. Informativeness is measured as the coefficient on future earnings (cash flows) in a regression of current stock return against current and future earnings (cash flows and accruals).

Findings

The findings suggest that income smoothing enhances the information content of the effect of stock price on future earnings, thus improving the ability of market participants to make informed decisions about the allocation of capital resources.

Originality/value

Although previous research on the subject of income smoothing in an emerging market has been documented, its effect on stock prices efficiency is largely unknown. Thus, this paper presents an approach to studying the effects of income smoothing and the knowledge that the ability to manage earnings could improve stock prices efficiency could be useful for academics and policymakers in this market.

Details

Asian Journal on Quality, vol. 12 no. 1
Type: Research Article
ISSN: 1598-2688

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Article

Peterson K. Ozili

This paper analyzes banking sector earnings management using loan loss provisions (LLPs) in the Fintech era.

Abstract

Purpose

This paper analyzes banking sector earnings management using loan loss provisions (LLPs) in the Fintech era.

Design/methodology/approach

Regression methodology was used to examine earnings management in the Fintech era.

Findings

The findings show evidence for bank income smoothing using LLPs. There is greater income smoothing in the second-wave Fintech era compared to the first-wave Fintech era, and the presence of strong institutions did not lower income smoothing in the second-wave era. Bank income smoothing is also greater in (1) Bank of International Settlement (BIS) and EU countries than in non-EU countries and G7 countries, (2) well-capitalized banking sectors and (3) during economic booms in the second-wave Fintech era.

Practical implications

The competition for loans and deposits by banks and Fintech lenders in the second-wave Fintech era created additional incentives for banks to engage in income smoothing to report competitive and stable earnings.

Originality/value

The study uses a unique approach to detect country-level earnings management in the banking sector. Also, this study extends the bank earnings management literature by introducing the Fintech era as a determinant of the extent of bank earnings management.

Details

International Journal of Managerial Finance, vol. ahead-of-print no. ahead-of-print
Type: Research Article
ISSN: 1743-9132

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Article

Awad Elsayed Awad Ibrahim, Tarek Abdelfattah and Khaled Hussainey

The authors examine whether managers switch from artificial income smoothing using discretionary accruals to real income smoothing around corporate governance reform in Egypt.

Abstract

Purpose

The authors examine whether managers switch from artificial income smoothing using discretionary accruals to real income smoothing around corporate governance reform in Egypt.

Design/methodology/approach

The sample comprises 61 non-financial companies listed on the Egyptian Stock Exchange for the years 2004–2011. The authors use discretionary accruals as a proxy for artificial income smoothing and income/loss from asset sales as a proxy for real income smoothing.

Findings

The authors offer a significant contribution to accounting literature by providing new empirical evidence on the trade-off between real smoothing technique (e.g. income/loss from asset sales) and discretionary accruals around governance reform in a developing country.

Research limitations/implications

This study suffers from some limitations. First, the study sample is limited to only 338 observations. However, this is due to collecting the data manually and to the small number of listed firms during the study period. Second, the study period ended in 2011 due to the unprecedented political instability after the 2011 Egyptian people revolution. Third, although this study examines the effect of corporate governance, not all the governance aspects have been examined in the study models due to the lack of data.

Practical implications

First, the results of the total samples reveal that managers prefer real income smoothing than accruals income smoothing. This result may confirm the literature arguments on the advantages of REM methods over AEM methods. Cohen et al. (2008) find that firms switch to manage earnings using REM methods and explain that REM methods are harder to detect because they depend on operating decisions (Schipper, 1989). REM can be undertaken anytime during the year (Gunny, 2010). Besides, REM could not be deemed a violation of accounting standards or regulations (MyVay, 2006).

Originality/value

The authors offer a significant contribution to accounting literature by providing new empirical evidence on the trade-off between real smoothing technique (e.g. income/loss from asset sales) and discretionary accruals around governance reform in a developing country.

Details

Journal of Applied Accounting Research, vol. 21 no. 4
Type: Research Article
ISSN: 0967-5426

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Article

Moade Fawzi Shubita

The purpose of this paper is to assess the practice of income smoothing in the Gulf Cooperation Council (GCC) emerging markets; Saudi Arabia, Kuwait, United Arab Emirates…

Abstract

Purpose

The purpose of this paper is to assess the practice of income smoothing in the Gulf Cooperation Council (GCC) emerging markets; Saudi Arabia, Kuwait, United Arab Emirates, Oman and Qatar. Then, to examine the impact of income smoothing on the earnings quality to decide whether income smoothing can serve as either a tool to enhance earnings quality or a tool for opportunistic behavior. Audit quality and corporate governance as additional factors are considered in this study.

Design/methodology/approach

The study methodology measures income smoothing behavior based on the coefficient of variation method. Earnings quality is measured as an outcome of the explained variations in stock returns by earnings based on the efficient market hypothesis. Audit quality is measured based on brand as higher quality assigned to auditor from any of the Big 4, while the corporate governance is addressed based on the extent of governmental ownership. The initial study sample comprises 55 companies over a ten year period, from 1999 to 2008; the final sample represents approximately 64 percent of the industrial sector that have public data during the study.

Findings

The results suggest that income smoothing behavior in the GCC markets has many variations in practice. Income smoothing, on average, improves earnings quality in three countries out of four, but not significantly for the whole sample based on earnings level. The earnings changes model demonstrated a positive and significant impact of income smoothing on earnings quality. Audit quality and earnings quality have a positive relationship within the region, and companies dominated by the government perform well in accordance with the earnings-return model.

Research limitations/implications

The study is limited to the industrial sector of the GCC.

Practical implications

The study opens the door to future applications to other sectors within the GCC, same sectors and other sectors for Middle East countries and other emerging markets.

Social implications

The study may foster a better understanding of accounting practices in the GCC and Middle East. The study reveals variations in different aspects among GCC countries, this matter should be considered in separate studies across different areas.

Originality/value

The study makes an original contribution to being the first to explore this topic in the GCC. Additionally, this study shows that the GCC markets have different characteristics in the practice and impact of income smoothing on earnings’ quality. Further, audit quality and corporate governance was investigated for each country and for the region, in addition to the interaction between these factors with the income smoothing and earnings quality.

Details

Journal of Accounting in Emerging Economies, vol. 5 no. 3
Type: Research Article
ISSN: 2042-1168

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Article

Ping‐Sheng Koh

This study examines the rarely investigated association between institutional ownership and income smoothing. The results support the predicted positive association…

Abstract

This study examines the rarely investigated association between institutional ownership and income smoothing. The results support the predicted positive association between institutional ownership and the likelihood of firms smoothing earnings towards their earnings trend in general. However, this association is not systematic across all firms. The positive association is most evident among profit firms with pre‐managed earnings above their earnings trend. No significant association is found for profit firms with pre‐managed earnings below their earnings trend and loss firms in general. This study also finds that, in Australia, while institutional ownership has a non‐linear association with income increasing earnings management (Koh, 2003), such association manifests itself within the income smoothing framework. The results of this study highlight the complexities in the association between institutional ownership and earnings management strategies, and future research can benefit by explicitly examining the trade‐offs between alternative earnings management incentives and the factors that affect the relative strength of these incentive trade‐offs.

Details

Accounting Research Journal, vol. 18 no. 2
Type: Research Article
ISSN: 1030-9616

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Article

Hervé Stolowy and Gaétan Breton

Accounts manipulation has been the subject of research, discussion and even controversy in several countries including the USA, Canada, the U.K., Australia, Finland and…

Abstract

Accounts manipulation has been the subject of research, discussion and even controversy in several countries including the USA, Canada, the U.K., Australia, Finland and France. The objective of this paper is to provide a comprehensive review of the literature and propose a conceptual framework for accounts manipulation. This framework is based on the possibility of wealth transfer between the different stake‐holders, and in practice, the target of the manipulation appears generally to be the earnings per share and the debt/equity ratio. The paper also describes the different actors involved and their potential gains and losses. We review the literature on the various techniques of accounts manipulation: earnings management, income smoothing, big bath accounting, creative accounting, and window‐dressing. The various definitions of all these, the main motivations behind their application and the research methodologies used are all examined. This study reveals that all the above techniques have common elements, but there are also important differences between them.

Details

Review of Accounting and Finance, vol. 3 no. 1
Type: Research Article
ISSN: 1475-7702

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Article

Anh Duc Ngo and Oscar Varela

The purpose of this paper is to examine the impact of earnings smoothing on the underpricing of seasoned equity offerings (SEOs). It aims to investigate whether earnings

Abstract

Purpose

The purpose of this paper is to examine the impact of earnings smoothing on the underpricing of seasoned equity offerings (SEOs). It aims to investigate whether earnings smoothing can add value to firms by reducing the degree of SEO underpricing.

Design/methodology/approach

The sample of US common stock seasoned equity offerings (SEOs) by non‐regulated firms during 1989‐2009 was used to conduct various cross‐section, univariate, and multivariate tests, using several proxies for earnings smoothing, in order to confirm the impact of earnings smoothing on the degree of SEO underpricing. Three‐stage least square estimation was used to address the possible endogeneity of pricing and earnings smoothing.

Findings

Smooth earnings performance resulting from discretionary accruals is negatively related to SEO underpricing and improves earnings informativeness. Consistent with risk management and signaling theories, managers' efforts to produce smooth earning reports may add value to their firms. Based on the mean values for SEOs, such smoothing reduces underpricing by $0.33 per share offered and increases the value of the average offering by $1.65 million. Smoothed earnings also conveys information about the firms' future performance, as firms with a long historical pattern of smooth earnings prior to SEOs significantly outperform, for at least three years after the SEO, those with more volatile earnings, with respect to stock returns and operating performance.

Originality/value

The paper contributes specifically to the current literature on earnings smoothing by demonstrating that high quality firms that expect larger quantity of cash flows in the near future are more likely to actively smooth earnings via discretionary accruals before SEOs to reduce underpricing. The paper contributes generally by showing that firms can signal their quality to outside investors by showing smooth earnings over a long period of time and such firms are more likely to experience a lower degree of underpricing through SEO episodes.

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Article

Peterson K. Ozili

The purpose of this paper is to empirically examine whether the way African banks use loan loss provisions (LLP) to smooth earnings is influenced by capital market…

Abstract

Purpose

The purpose of this paper is to empirically examine whether the way African banks use loan loss provisions (LLP) to smooth earnings is influenced by capital market motivations and the type of auditor, after controlling for non-discretionary determinants of provisions and fluctuations in the business cycle.

Design/methodology/approach

To test the income smoothing hypothesis, the model was estimated using panel least square with White’s robust standard error correction, as well as, with and without period fixed effect.

Findings

The findings support the income smoothing hypothesis and indicate that African banks use LLP to smooth earnings; listed African banks use LLP to smooth earnings to a greater extent compared to non-listed African banks, possibly, for capital market reasons; income smoothing via LLP is not reduced among African banks with Big 4 auditors; and after controlling for macroeconomic fluctuation, there is evidence that bank provisioning is procyclical with fluctuations in the business cycle.

Research limitations/implications

The findings have three implications. One, listed African banks smooth income because they are more visible to investors; investors do not view stock price fluctuations as a good signal. Securities market regulators in African countries should enforce strict disclosure rules that reduce earnings smoothing practices to improve the transparency of bank earnings in the region. Two, the presence of a Big 4 auditor did not improve the informativeness of LLP estimates among African banks. Three, the evidence for procyclical provisioning suggest the need for dynamic LLP system in Africa.

Originality/value

This paper is the first cross-country African study to investigate whether provisions-based income smoothing decreases with the presence of a Big 4 auditor. The findings indicate that this is not the case among African banks.

Details

Review of Accounting and Finance, vol. 16 no. 2
Type: Research Article
ISSN: 1475-7702

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Article

Raheel Safdar and Chen Yan

The purpose of this paper is to investigate whether income smoothing helps to reduce volatility in reported earnings and which firms are more inclined to be engaged in…

Abstract

Purpose

The purpose of this paper is to investigate whether income smoothing helps to reduce volatility in reported earnings and which firms are more inclined to be engaged in income smoothing.

Design/methodology/approach

The authors used negative correlation between pre-managed earnings of a firm and its discretionary accruals (DAs) as proxy for income smoothing and the firms having more negative correlation coefficient are expected to have lower volatility in their reported earnings. The authors used Kothari et al.’s (2005) version of modified-Jones model to estimate DAs and used least squares estimations to investigate the research questions using six-year (2007-2012) sample of non-financial firms listed over Karachi Stock Exchange, Pakistan.

Findings

The authors found that firms experiencing more volatility in economic activities and smaller firms are more aggressively involved in income smoothing. Moreover, a predominant majority (72.2 per cent) of firms in the sample are involved in income smoothing through accruals manipulation. Also, the authors found that firms which are more aggressively involved in income smoothing have lesser volatility in reported earnings. Lastly, the level of DAs per se does not have any impact on income smoothing.

Research limitations/implications

The proxy used for income smoothing, though the authors consider it to be better, is not the only one used in literature and the sample is limited to Pakistan.

Originality/value

This study adds to earnings management literature by providing evidence on extensive accrual manipulation for income smoothing in Pakistan.

Details

Journal of Accounting in Emerging Economies, vol. 6 no. 4
Type: Research Article
ISSN: 2042-1168

Keywords

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Article

Peterson K. Ozili and Erick R. Outa

The purpose of this paper is to examine the extent of bank earnings smoothing during mandatory International Financial Reporting Standards (IFRS) adoption in Nigeria, to…

Abstract

Purpose

The purpose of this paper is to examine the extent of bank earnings smoothing during mandatory International Financial Reporting Standards (IFRS) adoption in Nigeria, to determine whether mandatory IFRS adoption increased or decreased income smoothing among Nigerian banks.

Design/methodology/approach

The authors employ panel regression methodology to estimate the association between loan loss provisions (LLPs) and bank earnings.

Findings

The authorse find that the mandatory adoption of IFRS is associated with lower earnings smoothing among Nigerian banks, which implies that Nigerian banks do not use LLPs to smooth reported earnings during the mandatory IFRS adoption period. The authors find evidence for earnings smoothing via LLP during voluntary IFRS adoption. Earnings smoothing is not significantly associated with listed and non-listed Nigerian banks during voluntary and mandatory IFRS adoption. Overall, the findings indicate that mandatory IFRS adoption improves the informativeness and reliability of LLPs estimate by discouraging Nigerian banks from influencing LLPs for earnings smoothing purposes during the mandatory IFRS adoption. The findings of this paper are relevant to the debate on whether IFRS reporting improves the quality of financial reporting among firms in Nigeria.

Practical implications

Overall, the findings indicate that mandatory IFRS adoption improves the informativeness and reliability of LLPs estimate by discouraging Nigerian banks from influencing LLPs estimates to smooth earnings during the period of mandatory IFRS adoption.

Social implications

The implication of the study is that IFRS has higher accounting quality than local GAAP in Nigeria as it improves the quality and informativeness of accounting numbers (LLPs and earnings) reported by Nigerian banks during the period examined.

Originality/value

This study is the first attempt to focus on income smoothing during mandatory IFRS adoption in Nigeria.

Details

African Journal of Economic and Management Studies, vol. 10 no. 1
Type: Research Article
ISSN: 2040-0705

Keywords

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