Income Smoothing, Earnings Quality And Corporate Valuation

Income smoothing has been defined as the process of manipulating the time profile of earnings reports to make the reported income stream less variable, while not increasing reported earnings over the long run. As one form of earnings managements, the debates about its economic consequence are also very intensive. The regulators and the public have perceived income smoothing as problematic, especially since the debacle of the energy giant Enron; Academic research, however, argue that income smoothing may not be problematic because income smoothing is a process of estimating accruals, and estimation of accruals is the heart of financial reporting. The managers could choose one of the accounting policies to make the corporate value maximized.Prior empirical results about the relationship between income smoothing and corporate value are also mixed. Several studies indicate that income smoothing means a lower risk, and a lower risk leads to a lower corporate value. Other studies, on the other hand, indicate that income smoothing leads to a higher corporate value.Because of this, this paper considers both income smoothing and earnings quality to study what is the effect of income smoothing and earnings quality on corporate value. The main conclusions of this paper are as follow:Firstly, if considering only a single factor, income smoothing leads to a lower corporate value and higher earnings quality leads to a higher corporate value. Secondly, if considering both income smoothing and earnings quality, income smoothing and higher earnings quality together leads to a higher corporate value.This paper is an expansion on the basis of previous studies. By using china’s securities market’s data, this paper studies what is the effect of income smoothing and earnings quality on corporate value. The results help to know about the role of income smoothing and earnings quality in the corporate value. What’s more, it helps investors make a right securities investment strategy according to accounting earnings information and then optimize the allocation of resources in China’s securities market.