Abstract

http://ssrn.com/abstract=2213827
 
 

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Relationship-Specificity, Contract Enforceability, and Income Smoothing


Yiwei Dou


New York University (NYU) - Department of Accounting, Taxation & Business Law

Ole-Kristian Hope


University of Toronto - Rotman School of Management

Wayne B. Thomas


University of Oklahoma - Michael F. Price College of Business

February 8, 2013

Accounting Review, Forthcoming
Rotman School of Management Working Paper No. 2213827

Abstract:     
Contracting parties, such as the firm and its supplier, have cost-reducing incentives to make investments which support the unique transactions between them. However, to the extent that one party may renege on its contractual obligations, the other party incurring the cost of the relationship-specific investment bears additional risk and is less willing to invest such that sub-optimal investment occurs. In countries where enforceability of explicit contracts is particularly weak, parties have incentives to signal their willingness to fulfill implicit claims and maintain long-term relationships. We predict that firms engage in income smoothing to send such a signal to their suppliers. Consistent with these expectations, we find that firms that both reside in countries with weak contract enforceability and operate in industries with a greater need for relationship-specific investments tend to smooth reported income more. We further decompose income smoothing into “informational” and “garbled” components and find that results are driven by the informational component of income smoothing. Our results support the important role that accruals play in providing information in the presence of incomplete contracts.

Number of Pages in PDF File: 52

Keywords: Income Smoothing, Informational Component, Relationship-Specific Investments, Contract Enforceability, Legal Protection, International

JEL Classification: F14, F30, G30, K12, L14, M41, M43

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Date posted: February 9, 2013  

Suggested Citation

Dou, Yiwei and Hope, Ole-Kristian and Thomas, Wayne B., Relationship-Specificity, Contract Enforceability, and Income Smoothing (February 8, 2013). Accounting Review, Forthcoming; Rotman School of Management Working Paper No. 2213827. Available at SSRN: http://ssrn.com/abstract=2213827

Contact Information

Yiwei Dou
New York University (NYU) - Department of Accounting, Taxation & Business Law ( email )
40 West 4th Street
New York, NY 10012
United States
Ole-Kristian Hope (Contact Author)
University of Toronto - Rotman School of Management ( email )
105 St. George Street
Toronto, Ontario M5S 3E6
Canada
HOME PAGE: http://www.rotman.utoronto.ca/FacultyAndResearch/Faculty/FacultyBios/Hope.aspx
Wayne B. Thomas
University of Oklahoma - Michael F. Price College of Business ( email )
Michael F. Price College of Business,
307 W Brooks, Rm 212B
Norman, OK 73019
United States
405-325-5789 (Phone)
405-325-7348 (Fax)
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