The Effect of Income Smoothing on the Relative Value-relevance of Accounting Information

Abstract

This study examines the effect of income smoothing on the relative value-relevance of earnings and equity book value. Following Leuz et al. (2003), Myers et al. (2006), Tucker and Zarowin (2006), this study uses the current year's and past four years' observations to measure income smoothing by the negative correlation between the change in discretionary accruals and the change in pre-discretionary income. Using Ohlson (1995) model, this study finds that the more income smoothing, the more value-relevance increase of earnings; in contrast, the more value-relevance loss of equity book value. Furthermore, this paper finds that the more income smoothing, the more investors' positive reactions to the discretionary accruals. These results are robust to using cross-sectional modified Jones model to proxy the discretionary accruals, to controlling for debt ratio, negative earnings, return on equity, electronic industry effect, to deflating the related variables by total assets, and to using another income smoothing measure.