How Does Income Smoothing Affect the Cost of Private Debt?

55 Pages Posted: 17 Nov 2010 Last revised: 29 Oct 2016

Dan Amiram

Columbia Business School - Accounting, Business Law & Taxation

Edward L. Owens

Emory University - Department of Accounting

Date Written: October 28, 2016

Abstract

Private debt markets provide a major source of financing used by most corporations. Despite the fact that income smoothing by managers is a pervasive phenomenon that has been widely researched, we have little evidence, if any, on how smoothing is associated with cost of debt in the private loan market. The institutional factors associated with private loan contracts, combined with the theoretical motivations for smoothing, make it unclear whether smoothing will be positively, negatively, or not associated with loan spread. Using both cross-country and within-country analyses on an international sample of private loans, we predict and provide evidence that income smoothing is associated with lower cost of debt when the threat of private benefits consumption by managers is low, but is associated with higher cost of debt when the threat of private benefits consumption by managers is high. Our evidence is consistent with the theoretical coexistence of both the information signaling and garbling views of smoothing, and we identify private benefits consumption threat as the feature of the contracting environment that empirically reveals the bi-directional nature of the association between smoothing and cost of debt. In contrast to smoothing, neither accruals quality, conservatism, nor earnings persistence change sign in their relation with loan spread across environments, and our inferences regarding smoothing hold after controlling for these alternative accounting attributes.

Keywords: Income smoothing, Private benefits, Debt contracts

JEL Classification: F34, G15, G32, G34, M41

Suggested Citation

Amiram, Dan and Owens, Edward L., How Does Income Smoothing Affect the Cost of Private Debt? (October 28, 2016). Columbia Business School Research Paper No. 12/38. Available at SSRN: https://ssrn.com/abstract=1710122 or http://dx.doi.org/10.2139/ssrn.1710122

Dan Amiram

Columbia Business School - Accounting, Business Law & Taxation ( email )

3022 Broadway
New York, NY 10027
United States

Edward L. Owens (Contact Author)

Emory University - Department of Accounting ( email )

Goizueta Business School
1300 Clifton Road
Atlanta, GA 30322
United States

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