A Theory of Income Smoothing When Insiders Know More than Outsiders
Forthcoming, Review of Financial Studies
54 Pages Posted: 16 Nov 2011 Last revised: 24 Mar 2015
Date Written: March 10, 2015
We develop a theory of income and payout smoothing by firms when insiders know more about income than outside shareholders, but property rights ensure that outsiders can enforce a fair payout. Insiders set payout to meet outsiders’ expectations and underproduce to manage future expectations downward. The observed income and payout process are smooth and adjust partially and over time in response to economic shocks. The smaller the inside ownership, the more severe underproduction is, resulting in an “outside equity Laffer curve”.
Keywords: payout policy, asymmetric information, under-investment, finance and growth
JEL Classification: G32, G35, M41, M42, O43, D82, D92
Suggested Citation: Suggested Citation