Shared Illusion

This idea that earnings management, represented by smoothing earnings, can somehow be a good thing, as here:

…firms may smooth reported net income for external reporting purposes. If used responsibly, smoothing can convey inside information to the market by enabling the firm to credibly communicate its expected persistent earning power.

W. R. Scott, Financial Accounting Theory, Seventh Edition, p. 447.

Basic idea that smoothing of earnings lessens income volatility. Less income volatility means that the firm is perceived to be less risky. Less risk is associated with lower cost of capital. Therefore, when estimating (accruing) income or expenses, managers should consider the effects of such accruals on earnings, rather than making such estimates independent of earnings effects.

When may income be regarded as predictable or less volatile? The general chaos of life and world events makes predictable income patterns very difficult to justify. “Persistent” income–for how long?

Why would an efficient market respond to an income number that involves income and expenses estimated with reference to a desired income outcome?


What you say, what you say

About brucelarochelle
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