Determinants of Income Smoothing

In this study we examine whether managers of Australian listed companies are more likely to smooth corporate earnings as the political cost exposure of the firm and its management increases. We find that the incidence of smoothing increases as the firm's ratio of executive compensation to operating profits increases, and the higher the market concentration of the industry in which the firm operates. We argue that the former relation arises because managers attempt to avoid possible negative repercussions arising from apparent high compensation relative to returns to shareholders. Such repercussions could include revisions of their management compensation plans, or insecurity of job tenure. We also find that firms in industries with high market concentration smooth earnings more than firms in industries with low market concentration. This is consistent with attempts to avoid earnings peaks that can lead to accusations of profiteering at the expense of consumers. However, this latter finding is not robust to differences in sampling or alternative measures of income smoothing. Overall, the evidence indicates that managers smooth reported earnings to avert attention from recurring circumstances that can expose the firm and its managers to political scrutiny and criticism.