The smoothing hypothesis, stock returns and risk in Brazil

Abstract

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.

Análise da Influência da Presença da Suavização de Resultados sobre a Persistência dos Lucros no Mercado Brasileiro

“…However, for the Brazilian market, Martinez and Castro (2011) identified smoothing related to smaller companies, in contrast with the results found in the American and European markets. The authors explain this distinction via the possibility of risk perception offsetting behavior, in comparison with larger companies.…”

Exploring the Nature of Material Information: Disclosure and Its Implications

“…Finally, to test our hypothesis regarding whether the disclosure of MI is associated with earnings quality, we proposed the following research model: In accordance with previous studies (Martinez & Castro, 2010;Myers, Myers, & Skinner, 2007;Gassen, Flbier, & Sellhorn, 2006;Burgstahler, Hail, & Leuz, 2006;Francis, LaFond, Olsso, & Schipper, 2004;Bhattacharya & Sen, 2004;Leuz, Nanda, & Wysock, 2003), we used the SMOOTH variable as a proxy for earnings quality, which is equal to the standard deviation of net income before extraordinary items from t-5 to t-1, divided by the standard deviation of cash flow from operations from t-5 to t-1. Regarding the control variables in Eq.…”

Aspects of the quality of accounting in the international context

“…Castro and Martinez (2009) argue that the practice of income smoothing impacts on the cost of third party capital and on the capital structure of firms. The results of Martinez and Castro (2011a) indicate that income smoothing has a positive effect on systematic risk, reducing it and favoring the achievement of positive abnormal returns. Additionally, Martinez and Castro (2011b) point out that income smoothing has a positive impact on the rating of firms.…”