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Why Do Firms Smooth Earnings?

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  • Anand Mohan Goel

    (University of Michigan)

Abstract

We explain why a firm may smooth reported earnings. Greater earnings volatility leads to a bigger informational advantage for informed investors over uninformed investors. If sufficiently many current shareholders are uninformed and may need to trade in the future for liquidity reasons, an increase in the volatility of reported earnings will magnify these shareholders' trading losses. They will, therefore, want the manager to smooth reported earnings as much as possible. Empirical implications are drawn out that link earnings smoothing to managerial compensation contracts, uncertainty about the volatility of earnings, and ownership structure.

Suggested Citation

  • Anand Mohan Goel, 2003. "Why Do Firms Smooth Earnings?," The Journal of Business, University of Chicago Press, vol. 76(1), pages 151-192, January.
    • Handle: RePEc:ucp:jnlbus:v:76:y:2003:i:1:p:151-192
    DOI: 10.1086/344117
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