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Why Do Firms Smooth Earnings?

Author

Listed:
  • Anand Mohan Goel

    (University of Michigan)

  • Anjan V. Thakor

    (Olin School of Business, Washington University)

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 & Anjan V. Thakor, 2004. "Why Do Firms Smooth Earnings?," Finance 0411021, University Library of Munich, Germany.
    • Handle: RePEc:wpa:wuwpfi:0411021
    Note: Type of Document - pdf; pages: 42
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    References listed on IDEAS

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