Earnings Smoothing: Does It Exacerbate or Constrain Stock Price Crash Risk?

59 Pages Posted: 15 Dec 2014 Last revised: 2 Nov 2016

See all articles by Changling Chen

Changling Chen

University of Waterloo - School of Accounting and Finance

Jeong-Bon Kim

City University of Hong Kong

Li Yao

Concordia University, Quebec

Date Written: October 22, 16

Abstract

We examine the relation between earnings smoothing and stock price crash risk to evaluate the role of earnings smoothing on the downside risk of equity values. We find that, within firm, a higher degree of earnings smoothing is associated with greater crash risk; and this association, in the cross-section, is more pronounced for firms with fewer analysts following, smaller institutional holdings, and positive cumulative discretionary accruals. We also use stock returns to assess the economic significance of our results. We find that, controlling for firm fixed effects, earnings smoothing is associated with sizable negative returns in the quarter following the earnings announcement. Our findings caution investors about the downside risk of firms reporting smooth earnings, in contrast to the conventional belief that these firms are low in equity risk.

Keywords: Stock price crash risk, Earnings smoothing, Managerial opportunism, Private information signalling, External monitoring

JEL Classification: G12, G14, M41

Suggested Citation

Chen, Changling and Kim, Jeong-Bon and Yao, Li, Earnings Smoothing: Does It Exacerbate or Constrain Stock Price Crash Risk? (October 22, 16). Journal of Corporate Finance, Forthcoming. Available at SSRN: https://ssrn.com/abstract=2538155 or http://dx.doi.org/10.2139/ssrn.2538155

Changling Chen

University of Waterloo - School of Accounting and Finance ( email )

200 University Avenue West
Waterloo, Ontario N2L 3G1 N2L 3G1
Canada

Jeong-Bon Kim

City University of Hong Kong ( email )

Department of Accountancy
83 Tat Chee Avenue
Kowloon Tong
Hong Kong
852-3442-7909 (Phone)

Li Yao (Contact Author)

Concordia University, Quebec ( email )

1455 de Maisonneuve Blvd. W.
Montreal, Quebec H3G 1MB
Canada

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