Sign Reversal in the Relationship between Income Smoothing and Cost of Debt

32 Pages Posted: 8 Feb 2018

See all articles by Dan Amiram

Dan Amiram

Tel Aviv University - Coller School of Management

Edward Owens

University of Utah - David Eccles School of Business

Multiple version iconThere are 2 versions of this paper

Date Written: January/February 2018

Abstract

Despite the fact that income smoothing by managers is a pervasive phenomenon that has been widely researched, extant literature provides incomplete evidence on how smoothing is associated with cost of debt in general, and in the private loan market in particular. The institutional factors associated with private loan contracts, combined with the theoretical motivations for smoothing, make it unclear whether smoothing will be positively, negatively, or not associated with loan spread. Using both cross‐country and within‐country analyses on an international sample of private loans, we predict and provide evidence that income smoothing is associated with lower cost of debt when the threat of private benefits consumption by managers is low, but is associated with higher cost of debt when the threat of private benefits consumption by managers is high. We provide the first evidence in the literature that the garbling effect of smoothing can predictably dominate the signaling view of smoothing in debt contract design, and we identify private benefits consumption threat as the feature of the contracting environment that empirically reveals a sign reversal in the relationship between smoothing and cost of debt.

Keywords: debt contracts, income smoothing, private benefits

Suggested Citation

Amiram, Dan and Owens, Edward, Sign Reversal in the Relationship between Income Smoothing and Cost of Debt (January/February 2018). Journal of Business Finance & Accounting, Vol. 45, Issue 1-2, pp. 40-71, 2018. Available at SSRN: https://ssrn.com/abstract=3120066 or http://dx.doi.org/10.1111/jbfa.12295

Dan Amiram (Contact Author)

Tel Aviv University - Coller School of Management ( email )

Tel Aviv
Israel

Edward Owens

University of Utah - David Eccles School of Business ( email )

1645 E Campus Center Dr
Salt Lake City, UT 84112-9303
United States
8015815732 (Phone)

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