Does Real Earnings Smoothing Reduce Investors’ Perceived Risk?

Posted: 11 Jun 2019

See all articles by Jeong-Bon Kim

Jeong-Bon Kim

City University of Hong Kong

Jundong (Jeff) Wang

San Diego State University - Accountancy

Eliza Xia Zhang

University of Washington Tacoma

Date Written: May 25, 2019

Abstract

This study examines whether real earnings smoothing influences equity and credit investors’ perception of risk. Using a large sample of U.S. public firms during the period of 1996 through 2014, we find that real smoothing is negatively associated with option-implied volatility even after controlling for accrual-based smoothing and fundamental smoothing, suggesting that real smoothing lowers equity investors’ perception of risk. We also find that the association between real smoothing and equity investors’ perceived risk is stronger when dividend payouts are higher, balance sheet constraints are more severe, and accrual-based smoothing is greater. In addition, we find that real smoothing is negatively associated with CDS spreads, implying that real smoothing lowers creditors’ perception of risk as well. Our results are robust to a variety of sensitivity checks. Overall, our study documents a new factor that influences both equity and credit investors’ ex ante perception of risk.

Keywords: real earnings smoothing, accrual-based earnings smoothing, option-implied volatility, CDS spread, perceived risk

Suggested Citation

Kim, Jeong-Bon and Wang, Jundong (Jeff) and Zhang, Eliza Xia, Does Real Earnings Smoothing Reduce Investors’ Perceived Risk? (May 25, 2019). Available at SSRN: https://ssrn.com/abstract=3394376 or http://dx.doi.org/10.2139/ssrn.3394376

Jeong-Bon Kim

City University of Hong Kong ( email )

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

Jundong (Jeff) Wang

San Diego State University - Accountancy ( email )

United States

Eliza Xia Zhang (Contact Author)

University of Washington Tacoma ( email )

310 Dougan
Tacoma, WA WASHINGTON 98402
United States
5738235607 (Phone)
5738235607 (Fax)

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