Income Smoothing, Predictive Ability And Market Reaction

Income smoothing is a prevalent accounting phenomenon in capital market. With the development of China's capital market, income smoothing has become one of the focuses in China's capital market. Exploring income smoothing phenomenon can help us to understand its role in earnings quality and know the operational mechanism and investors'behavior characteristic in China's capital market; and then to improve the efficiency of resource allocation and enhance the maturity of China's capital market.At present, the debates about the economic consequence of income smoothing are still intensive. Some researches suggest that income smoothing may distort companies'accounting information and make investors misprice the stock. Other researches propose that income smoothing may improve usefulness of accounting information and according to which investors would make a proper stock price. So the effect of income smoothing on accounting information quality is an open, empirical question.This dissertation empirically analyzes the relationship between income smoothing and usefulness of earnings, using the data from China's A-Share Market. On one hand, it evaluates the economic consequence of income smoothing by examining the effect of income smoothing on predictive ability of earnings. On the other hand, it gives empirical evidences of the market reaction to earnings influenced by income smoothing to reflect the degree of investors'perception. Both of the above supplement each other and provide a whole picture about the role of income smoothing in China's security market. The main conclusions of this dissertation are as follow:1. Income smoothing can improve the ability of current earnings to predict future earnings and future cash flows. This improvement was realized by the two components of earnings: accruals and cash flows. 2. The direction of market reaction to earnings and its components influenced by income smoothing is positive. It is consistent with the effect on the predictive ability of earnings and its components taken by income smoothing.3. After controlling the related factors, such as risks, growth, it can be found that investors can not acquire the abnormal return through hedging the portfolios formed by income smoothing variable. So it proves that the market reaction to income smoothing is moderate to some extent.All conclusions presented above are tenable when taking net income as a proxy of earnings.This dissertation provides the comprehensive empirical evidences on the relationship between income smoothing and predictive ability of earnings, including the market reaction to earnings influenced by income smoothing. It makes us know the effect of income smoothing on earnings quality of China's listed companies and the degree of investors'perception on accounting information. It also helps investors take a right invest strategy according to accounting information and then improve the efficiency of resource allocation in China's capital market.