Does Real Earnings Smoothing Reduce Investors’ Perceived Risk?

Kim J-B,Wang JJ, Zhang EX. Does real earnings smoothing reduce investors’ perceived risk?. J Bus Fin Acc. 2021;1–36. https://doi.org/10.1111/jbfa.12529

65 Pages Posted: 11 Jun 2019 Last revised: 18 Jul 2022

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; University of Washington, Tacoma

Date Written: May 10, 2021

Abstract

This study examines whether real earnings smoothing influences equity and credit investors’ perceptions of risk. Using a large sample of U.S. public firms, we find that real earnings smoothing is negatively associated with option-implied volatility, suggesting that real earnings smoothing lowers equity investors’ perceived risk. We also find that real earnings smoothing is negatively associated with credit default swap spread, implying that real earnings smoothing lowers credit investors’ perceived risk. Our results are robust to multiple sensitivity analyses and to various tests used to address potential endogeneity. Moreover, the effect of real earnings smoothing is greater than that of accrual-based smoothing, suggesting that real earnings smoothing is more difficult for investors to detect and unravel. Overall, our study documents a new factor that influences both equity and credit investors’ ex ante perceptions of risk.

Keywords: real earnings smoothing; accrual-based earnings smoothing; option-implied volatility; credit default swap spread; perceived risk; credit investors; equity investors

JEL Classification: G12, G32, M41

Suggested Citation

Kim, Jeong-Bon and Wang, Jundong (Jeff) and Zhang, Eliza Xia and Zhang, Eliza Xia, Does Real Earnings Smoothing Reduce Investors’ Perceived Risk? (May 10, 2021). Kim J-B,Wang JJ, Zhang EX. Does real earnings smoothing reduce investors’ perceived risk?. J Bus Fin Acc. 2021;1–36. https://doi.org/10.1111/jbfa.12529, 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)

University of Washington, Tacoma

1900 Commerce Street
Tacoma, WA 98402-3100
United States

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