Income Smoothing, Earnings Quality and Firm Valuation

Abstract:  This study argues that lower variability of earnings does not guarantee income smoothers' higher firm values. Instead, smoothers' earnings should be more value-relevant if they are of high quality, i.e., earnings quality should be considered simultaneously. Sample firms are divided into four groups: quality earnings smoothers, quality earnings non-smoothers, non-quality earnings smoothers, and non-quality earnings non-smoothers. Value relevance of reported earnings is then studied using both the levels and the changes approaches with indicator variables. Results show quality earnings smoothers have the highest price-earnings multiple while non-quality non-smoothers have the lowest price-earnings multiple. Copyright Blackwell Publishers Ltd, 2004.