A Theory of Income Smoothing When Insiders Know More than Outsiders

51 Pages Posted: 16 Mar 2012

See all articles by Viral V. Acharya

Viral V. Acharya

New York University - Leonard N. Stern School of Business; Centre for Economic Policy Research (CEPR); National Bureau of Economic Research (NBER); New York University (NYU) - Department of Finance

Bart M. Lambrecht

University of Cambridge - Judge Business School; Centre for Economic Policy Research (CEPR)

Multiple version iconThere are 4 versions of this paper

Date Written: March 13, 2012

Abstract

We consider a setting in which insiders have information about income that outside shareholders do not, but property rights ensure that outside shareholders can enforce a fair payout. To avoid intervention, insiders report income consistent with outsiders' expectations based on publicly available information rather than true income, resulting in an observed income and payout process that adjust partially and over time towards a target. Insiders underproduce in an attempt not to unduly raise outsiders' expectations about future income, a problem that is more severe the smaller is the inside ownership. This results in an "outside equity Laffer curve" in that the total outside equity value is an inverted U-shaped function of outsiders' ownership share. A disclosure environment with adequate quality of independent auditing mitigates this problem, implying that accounting quality can enhance investments, size of public stock markets and economic growth.

Keywords: payout policy, asymmetric information, under-investment, accounting quality, finance and growth

JEL Classification: G32, G35, M41, M42, O43, D82, D92

Suggested Citation

Acharya, Viral V. and Lambrecht, Bart, A Theory of Income Smoothing When Insiders Know More than Outsiders (March 13, 2012). Available at SSRN: https://ssrn.com/abstract=2023116 or http://dx.doi.org/10.2139/ssrn.2023116

Viral V. Acharya

New York University - Leonard N. Stern School of Business ( email )

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Suite 9-160
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United States

HOME PAGE: http://pages.stern.nyu.edu/~sternfin/vacharya/public_html/~vacharya.htm

Centre for Economic Policy Research (CEPR)

London
United Kingdom

National Bureau of Economic Research (NBER)

1050 Massachusetts Avenue
Cambridge, MA 02138
United States

New York University (NYU) - Department of Finance

Stern School of Business
44 West 4th Street
New York, NY 10012-1126
United States

Bart Lambrecht (Contact Author)

University of Cambridge - Judge Business School ( email )

Trumpington Street
Cambridge, CB2 1AG
United Kingdom
44-(0)-1223-339700 (Phone)
44-(0)-1223-339701 (Fax)

Centre for Economic Policy Research (CEPR) ( email )

London
United Kingdom

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