Does real earnings smoothing reduce investors’ perceived risk?

Research output: Journal Publications and Reviews (RGC: 21, 22, 62)21_Publication in refereed journalpeer-review

1 Scopus Citations
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Detail(s)

Original languageEnglish
Number of pages36
Journal / PublicationJournal of Business Finance and Accounting
Online published30 Apr 2021
Publication statusOnline published - 30 Apr 2021

Abstract

This study examines whether real earnings smoothing influences equity and credit investors’ perceptions of risk. Using a large sample of US public firms, we find that real earnings smoothing is negatively associated with option-implied volatility, suggesting that real earnings smoothing lowers equity investors’ perceived risk. We also find that real earnings smoothing is negatively associated with credit default swap spread, implying that real earnings smoothing lowers credit investors’ perceived risk. Our results are robust to multiple sensitivity analyses and to various tests used to address potential endogeneity. Moreover, the effect of real earnings smoothing is greater than that of accrual-based smoothing, suggesting that real earnings smoothing is more difficult for investors to detect and unravel. Overall, our study documents a new factor that influences both equity and credit investors’ ex-ante perceptions of risk.

Research Area(s)

  • accrual-based earnings smoothing, credit default swap spread, credit investors, equity investors, option-implied volatility, perceived risk, real earnings smoothing