Income Smoothing and Incentives: Empirical Tests Using Accounting Changes.

Abstract ABSTRACT: In this study it is hypothesized that various firm-specific factors provide incentives for management to use accounting choices to smooth earnings, and that as a result, smoothing behavior varies across firms. Accounting changes are investigated as a smoothing device. T-tests and regression analysis are used to test the relation between smoothing and a set of explanatory variables. Findings provide evidence that smoothing is associated with firm size, the existence of bonus compensation plans, and the divergence of actual earnings from expectations. In addition, findings indicate that smoothing, by accounting changes is associated with the impact of the accounting change on the level of earnings. This is consistent with management recognizing and making trade-offs between the effect of accounting choices on both income levels and income variability.