Do Managers Smooth Income in Anticipation of Future Earnings?
Posted: 9 Jul 1998
Date Written: January 1996
Prior research has focused on management's concern with current relative performance to explain income smoothing. Recent economic theory, however, argues that concern about job security creates an incentive for managers to also consider anticipated future relative performance. Our empirical analysis supports this theory. We find that when current earnings are "poor" and expected future earnings are "good", managers make income-increasing discretionary accruals in the current period. This is consistent with managers "borrowing" earnings from the future for use in the current period in order to reduce the threat of dismissal. Conversely, when current earnings are "good" and expected future earnings are "poor," managers make income-decreasing discretionary accruals in the current period. This is consistent with managers "saving" current earnings for possible use in the future. We also show that our results are not explained by managers using discretionary accruals to signal future performance. This paper contributes to the literature by identifying expected future earnings as a determinant of income smoothing. This is consistent with job security concerns motivating income smoothing.
JEL Classification: J30, M41
Suggested Citation: Suggested Citation