IDEAS home Printed from https://ideas.repec.org/a/eee/reveco/v85y2023icp93-106.html
   My bibliography  Save this article

Economic policy uncertainty and incentive to smooth earnings

Author

Listed:
  • Chauhan, Yogesh
  • Jaiswall, Manju

Abstract

We examine how economic policy-induced uncertainty influences managers' discretionary accounting choices to achieve a smoother earnings stream. We find that managers offset the partial risk of policy uncertainty on reported earnings by using discretionary accruals. We mainly observe that firms report more negative discretionary accruals when managers are less certain about their prospects. We further show that managers' engagement in income-decreasing earnings management is more significant when firms’ current period pre-managed earnings are higher. To complete the story, we also find that the propensity of reversal of discretionary accruals is positively associated with levels of policy uncertainty. Our results imply that managers opportunistically use discretionary accruals around an uncertain exogenous environment to smooth earnings.

Suggested Citation

  • Chauhan, Yogesh & Jaiswall, Manju, 2023. "Economic policy uncertainty and incentive to smooth earnings," International Review of Economics & Finance, Elsevier, vol. 85(C), pages 93-106.
    • Handle: RePEc:eee:reveco:v:85:y:2023:i:c:p:93-106
    DOI: 10.1016/j.iref.2023.01.014
    as

    Download full text from publisher

    File URL: http://www.sciencedirect.com/science/article/pii/S1059056023000229
    Download Restriction: Full text for ScienceDirect subscribers only
    File URL: https://libkey.io/10.1016/j.iref.2023.01.014?utm_source=ideas
    LibKey link: if access is restricted and if your library uses this service, LibKey will redirect you to where you can use your library subscription to access this item
    ---><---

    As the access to this document is restricted, you may want to search for a different version of it.

    References listed on IDEAS

    as
    1. Nicholas Bloom & Max Floetotto & Nir Jaimovich & Itay Saporta†Eksten & Stephen J. Terry, 2018. "Really Uncertain Business Cycles," Econometrica, Econometric Society, vol. 86(3), pages 1031-1065, May.
    2. Nguyen, Nam H. & Phan, Hieu V., 2017. "Policy Uncertainty and Mergers and Acquisitions," Journal of Financial and Quantitative Analysis, Cambridge University Press, vol. 52(2), pages 613-644, April.
    3. Fudenberg, Drew & Tirole, Jean, 1995. "A Theory of Income and Dividend Smoothing Based on Incumbency Rents," Journal of Political Economy, University of Chicago Press, vol. 103(1), pages 75-93, February.
    4. Mark H. Lang & Karl V. Lins & Darius P. Miller, 2003. "ADRs, Analysts, and Accuracy: Does Cross Listing in the United States Improve a Firm's Information Environment and Increase Market Value?," Journal of Accounting Research, Wiley Blackwell, vol. 41(2), pages 317-345, May.
    5. Barth, ME & Elliott, JA & Finn, MW, 1999. "Market rewards associated with patterns of increasing earnings," Journal of Accounting Research, Wiley Blackwell, vol. 37(2), pages 387-413.
    6. Scott R. Baker & Nicholas Bloom & Steven J. Davis, 2016. "Measuring Economic Policy Uncertainty," The Quarterly Journal of Economics, President and Fellows of Harvard College, vol. 131(4), pages 1593-1636.
    7. Brandon Julio & Youngsuk Yook, 2012. "Political Uncertainty and Corporate Investment Cycles," Journal of Finance, American Finance Association, vol. 67(1), pages 45-84, February.
    8. Ghosh, Dipankar & Olsen, Lori, 2009. "Environmental uncertainty and managers' use of discretionary accruals," Accounting, Organizations and Society, Elsevier, vol. 34(2), pages 188-205, February.
    9. Peter Demerjian & John Donovan & Melissa F. Lewis‐Western, 2020. "Income Smoothing and the Usefulness of Earnings for Monitoring in Debt Contracting," Contemporary Accounting Research, John Wiley & Sons, vol. 37(2), pages 857-884, June.
    10. Anand Mohan Goel, 2003. "Why Do Firms Smooth Earnings?," The Journal of Business, University of Chicago Press, vol. 76(1), pages 151-192, January.
    11. Graham, John R. & Harvey, Campbell R. & Rajgopal, Shiva, 2005. "The economic implications of corporate financial reporting," Journal of Accounting and Economics, Elsevier, vol. 40(1-3), pages 3-73, December.
    12. DeFond, Mark L. & Park, Chul W., 1997. "Smoothing income in anticipation of future earnings," Journal of Accounting and Economics, Elsevier, vol. 23(2), pages 115-139, July.
    13. Boochun Jung & Naomi Soderstrom & Yanhua Sunny Yang, 2013. "Earnings Smoothing Activities of Firms to Manage Credit Ratings," Contemporary Accounting Research, John Wiley & Sons, vol. 30(2), pages 645-676, June.
    14. Bergstresser, Daniel & Philippon, Thomas, 2006. "CEO incentives and earnings management," Journal of Financial Economics, Elsevier, vol. 80(3), pages 511-529, June.
    15. Lang, Mark & Smith Raedy, Jana & Wilson, Wendy, 2006. "Earnings management and cross listing: Are reconciled earnings comparable to US earnings?," Journal of Accounting and Economics, Elsevier, vol. 42(1-2), pages 255-283, October.
    16. Leuz, Christian & Nanda, Dhananjay & Wysocki, Peter D., 2003. "Earnings management and investor protection: an international comparison," Journal of Financial Economics, Elsevier, vol. 69(3), pages 505-527, September.
    17. Yung, Kenneth & Root, Andrew, 2019. "Policy uncertainty and earnings management: International evidence," Journal of Business Research, Elsevier, vol. 100(C), pages 255-267.
    18. Joseph Aharony & Chan†Jane Lin & Martin P. Loeb, 1993. "Initial Public Offerings, Accounting Choices, and Earnings Management," Contemporary Accounting Research, John Wiley & Sons, vol. 10(1), pages 61-81, September.
    19. Cohen, Daniel A. & Zarowin, Paul, 2010. "Accrual-based and real earnings management activities around seasoned equity offerings," Journal of Accounting and Economics, Elsevier, vol. 50(1), pages 2-19, May.
    20. Nagar, Venky & Schoenfeld, Jordan & Wellman, Laura, 2019. "The effect of economic policy uncertainty on investor information asymmetry and management disclosures," Journal of Accounting and Economics, Elsevier, vol. 67(1), pages 36-57.
    21. Fama, Eugene F. & French, Kenneth R., 1993. "Common risk factors in the returns on stocks and bonds," Journal of Financial Economics, Elsevier, vol. 33(1), pages 3-56, February.
    22. Michael Clement & Richard Frankel & Jeffrey Miller, 2003. "Confirming Management Earnings Forecasts, Earnings Uncertainty, and Stock Returns," Journal of Accounting Research, Wiley Blackwell, vol. 41(4), pages 653-679, September.
    23. Healy, Paul M., 1985. "The effect of bonus schemes on accounting decisions," Journal of Accounting and Economics, Elsevier, vol. 7(1-3), pages 85-107, April.
    24. Huseyin Gulen & Mihai Ion, 2016. "Editor's Choice Policy Uncertainty and Corporate Investment," The Review of Financial Studies, Society for Financial Studies, vol. 29(3), pages 523-564.
    Full references (including those not matched with items on IDEAS)

    Citations

    Citations are extracted by the CitEc Project, subscribe to its RSS feed for this item.
    as


    Cited by:

    1. Alessandro Paolo Rigamonti & Giulio Greco & Mariarita Pierotti & Alessandro Capocchi, 2024. "Macroeconomic uncertainty and earnings management: evidence from commodity firms," Review of Quantitative Finance and Accounting, Springer, vol. 62(4), pages 1615-1649, May.
    2. Catalin Mos, 2024. "Uncertainty, Financial Reporting Quality and Accounting Enforcement: Evidence from The European Union," Journal of Accounting and Management Information Systems, Faculty of Accounting and Management Information Systems, The Bucharest University of Economic Studies, vol. 23(3), pages 616-642, September.
    3. Lean, Hooi Hooi & Alkhazali, Osamah M. & Gleason, Kimberley & Yeap, Xiu Wei, 2024. "Connectedness and economic policy uncertainty spillovers to the ASEAN stock markets," International Review of Economics & Finance, Elsevier, vol. 90(C), pages 167-186.
    4. Rigamonti, Alessandro Paolo & Greco, Giulio & Capocchi, Alessandro, 2024. "Futures, provisional sales, and earnings management in the global gold mining industry," Finance Research Letters, Elsevier, vol. 59(C).
    5. A Srivastava, 2024. "Bankruptcy Law, Creditor Rights, and Earnings Management: Evidence from India," Economic Issues Journal Articles, Economic Issues, vol. 29(2), pages 77-100, September.
    6. Catalin MOS, 2024. "Economic Policy Uncertainty, Financial Reporting Quality, and Audit Fees: Examining the Role of Industry Characteristics and International Accounting Standards," The Audit Financiar journal, Chamber of Financial Auditors of Romania, vol. 22(176), pages 791-802, October.
    7. Chada, Swechha, 2023. "Economic policy uncertainties and institutional ownership in India," The Journal of Economic Asymmetries, Elsevier, vol. 27(C).
    8. Hu, Debao & Lu, Jingming & Zhao, Sibo, 2024. "Does trade policy uncertainty increase commercial banks’ risk-taking? Evidence from China," International Review of Economics & Finance, Elsevier, vol. 89(PB), pages 532-551.

    Most related items

    These are the items that most often cite the same works as this one and are cited by the same works as this one.
    1. Bouwman, Christa H.S., 2014. "Managerial optimism and earnings smoothing," Journal of Banking & Finance, Elsevier, vol. 41(C), pages 283-303.
    2. Alessandro Paolo Rigamonti & Giulio Greco & Mariarita Pierotti & Alessandro Capocchi, 2024. "Macroeconomic uncertainty and earnings management: evidence from commodity firms," Review of Quantitative Finance and Accounting, Springer, vol. 62(4), pages 1615-1649, May.
    3. Jo, Eun Hye & Lee, Jung Wha, 2024. "Economic policy uncertainty and managerial short-termism," International Review of Financial Analysis, Elsevier, vol. 93(C).
    4. Ma, Huanyu & Hao, Dapeng, 2022. "Economic policy uncertainty, financial development, and financial constraints: Evidence from China," International Review of Economics & Finance, Elsevier, vol. 79(C), pages 368-386.
    5. Hanwen Chen & Siyi Liu & Xin Liu & Jiani Wang, 2022. "Opportunistic timing of management earnings forecasts during the COVID‐19 crisis in China," Accounting and Finance, Accounting and Finance Association of Australia and New Zealand, vol. 62(S1), pages 1495-1533, April.
    6. Wang, Fengrong & Mbanyele, William & Muchenje, Linda, 2022. "Economic policy uncertainty and stock liquidity: The mitigating effect of information disclosure," Research in International Business and Finance, Elsevier, vol. 59(C).
    7. Jeffrey Ng & Walid Saffar & Janus Jian Zhang, 2020. "Policy uncertainty and loan loss provisions in the banking industry," Review of Accounting Studies, Springer, vol. 25(2), pages 726-777, June.
    8. Theodora Bermpei & Antonios Nikolaos Kalyvas & Lorenzo Neri & Antonella Russo, 2022. "Does economic policy uncertainty matter for financial reporting quality? Evidence from the United States," Review of Quantitative Finance and Accounting, Springer, vol. 58(2), pages 795-845, February.
    9. Naser Makarem & Harjinder Singh & Nigar Sultana & Darren Henderson, 2023. "Policy uncertainty and real activities manipulation: evidence from Brexit," Review of Quantitative Finance and Accounting, Springer, vol. 61(4), pages 1415-1440, November.
    10. Allayannis, George & Simko, Paul J., 2022. "Discretionary earnings smoothing, credit quality, and firm value," Journal of Banking & Finance, Elsevier, vol. 140(C).
    11. Wu, Wei-Shao & Fok, Robert C.W. & Chang, Yuanchen & Chen, Chao-Jung, 2022. "Credit default swaps and corporate performance smoothing," Journal of Corporate Finance, Elsevier, vol. 75(C).
    12. Dechow, Patricia & Ge, Weili & Schrand, Catherine, 2010. "Understanding earnings quality: A review of the proxies, their determinants and their consequences," Journal of Accounting and Economics, Elsevier, vol. 50(2-3), pages 344-401, December.
    13. Silhan, Peter A., 2014. "Income smoothing from a Census X-12 perspective," Advances in accounting, Elsevier, vol. 30(1), pages 106-115.
    14. Xue, Xingnan & Hu, Nan, 2023. "Economic policy uncertainty and imitation behaviors of corporate social responsibility practices: Evidence from China," International Review of Financial Analysis, Elsevier, vol. 89(C).
    15. Sha, Yezhou & Qiao, Lu & Li, Suyang & Bu, Ziwen, 2021. "Political freedom and earnings management," Journal of International Financial Markets, Institutions and Money, Elsevier, vol. 75(C).
    16. Cao, Zhangfan & Rees, William & Zhang, Zhifang, 2023. "The effect of real earnings smoothing on corporate labour investment," The British Accounting Review, Elsevier, vol. 55(6).
    17. Dung Viet Tran & M. Kabir Hassan & Reza Houston, 2020. "Discretionary loan loss provision behavior in the US banking industry," Review of Quantitative Finance and Accounting, Springer, vol. 55(2), pages 605-645, August.
    18. Attig, Najah & El Ghoul, Sadok & Guedhami, Omrane & Zheng, Xiaolan, 2021. "Dividends and economic policy uncertainty: International evidence," Journal of Corporate Finance, Elsevier, vol. 66(C).
    19. Puyou, François-Régis, 2014. "Ordering collective performance manipulation practices: How do leaders manipulate financial reporting figures in conglomerates?," CRITICAL PERSPECTIVES ON ACCOUNTING, Elsevier, vol. 25(6), pages 469-488.
    20. Attig, Najah & Driss, Hamdi & El Ghoul, Sadok, 2021. "Credit ratings quality in uncertain times," Journal of International Financial Markets, Institutions and Money, Elsevier, vol. 75(C).

    More about this item

    Keywords

    Earnings management; Discretionary accruals; Policy uncertainty; India;
    All these keywords.

    JEL classification:

    • G18 - Financial Economics - - General Financial Markets - - - Government Policy and Regulation
    • G31 - Financial Economics - - Corporate Finance and Governance - - - Capital Budgeting; Fixed Investment and Inventory Studies

    Statistics

    Access and download statistics

    Corrections

    All material on this site has been provided by the respective publishers and authors. You can help correct errors and omissions. When requesting a correction, please mention this item's handle: RePEc:eee:reveco:v:85:y:2023:i:c:p:93-106. See general information about how to correct material in RePEc.

    If you have authored this item and are not yet registered with RePEc, we encourage you to do it here. This allows to link your profile to this item. It also allows you to accept potential citations to this item that we are uncertain about.

    If CitEc recognized a bibliographic reference but did not link an item in RePEc to it, you can help with this form .

    If you know of missing items citing this one, you can help us creating those links by adding the relevant references in the same way as above, for each refering item. If you are a registered author of this item, you may also want to check the "citations" tab in your RePEc Author Service profile, as there may be some citations waiting for confirmation.

    For technical questions regarding this item, or to correct its authors, title, abstract, bibliographic or download information, contact: Catherine Liu (email available below). General contact details of provider: http://www.elsevier.com/locate/inca/620165 .

    Please note that corrections may take a couple of weeks to filter through the various RePEc services.

    IDEAS is a RePEc service. RePEc uses bibliographic data supplied by the respective publishers.