The relationship between the smoothing of reported income and risk-adjusted returns

Michelson, Stuart; Jordan-Wagner, James; Wootton, Charles W.

doi:10.1007/bf02752709

Cited by 53 publications

(46 citation statements)

References 31 publications

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“…The international literature, works on the relationship between market returns and the degree of income smoothing in business include those of Wooton (1995, 1999), Booth, Kallunki and Martikainen (1996), Bin, Wan and Kamil (2000), Iñiguez and Poveda (2004), Bao and Bao (2004), Tan and Jamal (2006), Tucker and Zarowin (2006) and Grant, Markarian and Parbonetti (2007), analyzing the American, Finnish, Malay and Spanish markets. Of these, only those of Michelson et al (1995Michelson et al ( , 1999 and Iñiguez and Poveda (2004) contain long-term analyses, and the authors come to very different conclusions, working with different methodologies.…”

Section: Introductionmentioning

confidence: 99%

The smoothing hypothesis, stock returns and risk in Brazil

Martinez

Castro

2011

BAR, Braz. Adm. Rev.

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Income smoothing is defined as the deliberate normalization of income in order to reach a desired trend. If the smoothing causes more information to be reflected in the stock price, it is likely to improve the allocation of resources and can be a critical factor in investment decisions. This study aims to build metrics to determine the degree of smoothing in Brazilian public companies, to classify them as smoothing and non-smoothing companies and additionally to present evidence on the long-term relationship between the smoothing hypothesis and stock return and risk. Using the Economatica and CVM databases, this study focuses on 145 companies in the period 1998-2007. We find that Brazilian smoothers have a smaller degree of systemic risk than non-smoothers. In average terms, the beta of smoothers is significantly lower than non-smoothers. Regarding return, we find that the abnormal annualized returns of smoothers are significantly higher. We confirm differences in the groups by nonparametric and parametric tests in cross section or as time series, indicating that there is a statistically significant difference in performance in the Brazilian market between firms that do and do not engage in smoothing.

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Section: Introductionmentioning

confidence: 99%

The smoothing hypothesis, stock returns and risk in Brazil

Martinez

Castro

2011

BAR, Braz. Adm. Rev.

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“…The demand for earnings stability can, for instance, be driven by contracting purposes (Asquith et al 2005;Beatty et al 2002;Gaver et al 1995), and managing earnings risk can also be potentially rewarding from an asset-pricing perspective. Francis et al (2003) document higher price-earnings multiples for firms with smooth earnings, whereas Michelson et al (2000) show that U.S. earnings smoothers have a higher cumulative abnormal return than non-smoothers. These findings could indirectly be linked to dividend smoothing.…”

Section: Introductionmentioning

confidence: 93%

“…3 illustrates that for companies with strong preferences for earnings stability, an accounting change has the potential to alter companies' derivatives portfolios in ways that can induce dramatic increases in the cash flow volatility. If earnings volatility affects company value, as suggested by Michelson et al (2000), among others, the change in hedging strategies could be rational in an economic sense. However, if the preference for stable earnings documented by Graham et al (2005Graham et al ( , 2006Graham et al ( , 2007 is more or less irrational or based on temporary market inefficiencies (cf., e.g., the classical study of Sloan (1996), who documents that investors in the short run tend to "fixate" on earnings), the change in risk management is more problematic.…”

Section: Simulated Cash-flow Volatilitymentioning

confidence: 99%

How fair-value accounting can influence firm hedging

Beisland

Frestad

2012

Rev Deriv Res

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The potential influence of accounting regulations on hedging strategies and the use of financial derivatives is a research topic that has attracted little attention in both the finance and the accounting literature. However, recent surveys suggest that company hedging can be substantially influenced by the accounting for financial instruments. In this study, we illustrate not only why but also how the accounting regulations may affect hedging behavior. We find that under mark-to-market accounting, most firms concerned with earnings smoothness adopt myopic hedging strategies relative to the benchmark, cash flow hedging. The specific influence of the accounting regulations depends on market and firm-specific characteristics, but, in general, the firms dramatically reduce the extent of hedging addressing price risk in future accounting periods. We illustrate that the change in hedging behavior significantly dampens the increase in earnings volatility stemming from fair value accounting of derivatives. However, the adjusted hedging strategies may substantially increase the firms' cash flow volatility.

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“…Some researchers found that companies with smooth profits provide above-average longterm returns (Billings 1999;Michelson et al 2000). However, McInnis (2010) found no statistically significant relationship between earnings smoothness and stock returns and some other studies indicated that relatively smooth earnings entail below-average stock returns (Booth 1996;Singer 2007;Aflatooni and Nikbakht 2010).…”

Section: Past Earnings Smoothness and Stock Returnsmentioning

confidence: 99%

Impact of Earnings Smoothness on Stock Prices, Stock Returns and Future Earnings Changes - the Polish Experience

Welc¹

2014

EFAJ

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The relationship between the smoothing of reported income and risk-adjusted returns

Cited by 53 publications

References 31 publications

The smoothing hypothesis, stock returns and risk in Brazil

The smoothing hypothesis, stock returns and risk in Brazil

How fair-value accounting can influence firm hedging

Impact of Earnings Smoothness on Stock Prices, Stock Returns and Future Earnings Changes - the Polish Experience

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