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Income Smoothing and the Cost of Debt

28 Pages Posted: 7 Jun 2010  

Si Li

Wilfrid Laurier University - School of Business & Economics

Nivine Richie

University of North Carolina Wilmington

Date Written: January 2009

Abstract

Using the Tucker-Zarowin (TZ) statistic of income smoothing, we find firms with higher income smoothing rankings exhibit lower cost of debt and higher credit ratings. Multivariate analysis reveals that firms with higher financial leverage and lower credit ratings experience are associated with higher borrowing costs, but that such borrowing costs can be reduced by smoothing reported income. Furthermore, larger firms and firms with greater stock return volatility and who exhibit higher income smoothing rankings experience relative higher borrowing costs. Results support the notion that for smaller firms with lower stock return volatility, income smoothing represents information signaling rather than garbling.

Keywords: Income smoothing, earnings smoothing, garbling, credit spreads, credit ratings, cost of debt

JEL Classification: G12, G32, M41

Suggested Citation

Li, Si and Richie, Nivine, Income Smoothing and the Cost of Debt (January 2009). Available at SSRN: https://ssrn.com/abstract=1621760 or http://dx.doi.org/10.2139/ssrn.1621760

Si Li (Contact Author)

Wilfrid Laurier University - School of Business & Economics ( email )

Waterloo, Ontario N2L 3C5
Canada

Nivine Richie

University of North Carolina Wilmington ( email )

Wilmington, NC 28403
United States

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