Do Creditors Prefer Smooth Earnings? Evidence from European Private Firms
49 Pages Posted: 16 Sep 2014 Last revised: 31 Mar 2015
Date Written: February 20, 2015
We investigate the interplay between creditor financing and the smoothness of earnings reported by European private firms and document how heterogeneous debt-contracting infrastructures across Europe moderate this relation. Most European private firms are owner-manager run enterprises with private creditors as central outside stakeholders. In this setting we expect the smoothness of earnings to be positively related to the relative importance of these stakeholders. More importantly, we expect this relation to be more pronounced in regimes with higher bankruptcy and contract enforcement costs. Finally, we hypothesize that earnings smoothness is negatively related to the cost of debt of firms in these countries. Our large-sample empirical evidence confirms our expectations. While the cross-sectional nature of our setting limits our potential to address endogeneity concerns and thus caution is required when interpreting our findings in a causal way, they are consistent with the accounting of European private firms being shaped by creditor incentives and with this link being moderated by the country-level efficiency of the debt-contracting infrastructure.
Keywords: earnings smoothness, private firms, creditors
JEL Classification: M41, G32
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