Income Smoothing and Risk-Adjusted Performance

Abstract

This paper uses risk-adjusted returns to test whether the stock market response to accounting performance measures is related to the smoothness of companies' reported earnings. Three income models, increasing in their degree of smoothness, are created to test the hypotheses. Cumulative average abnormal returns are utilized for the income models over the study periods to test for a market response to income smoothing. The results indicate that companies that report smooth income have significantly higher cumulative average abnormal returns than firms that do not. When size is considered, market returns are stronger for small companies than for large companies. There is also a significant relationship between the type of industry and income smoothing.

JEL Classification: M41, M43, G12