Firm Financing and Accounting Discretion: A study of income smoothing in Sweden

University essay from Handelshögskolan i Stockholm/Institutionen för redovisning och finansiering

Abstract: Income smoothing is the reduction of inter-temporal variation in earnings. A smooth earnings path has been documented as an important consideration for managers. This study investigates the relationship between a firm's sources of financing and the use of accounting discretion for income smoothing. A version of the Jones (1991) model is used to estimate discretionary accruals and a cross-sectional regression with several control variables is performed to test the hypotheses. There are two main findings of the study. First, it is found that firms smooth earnings to a lesser extent when insiders hold a larger share of equity capital. Second, it is found that, contrary to the hypothesis presented, a higher degree of supplier financing is associated with a higher level of income smoothing. The results can be of interest to standard setters for broadening the view of the factors that impact discretionary accounting decisions. The results can also be of interest to investors who seek to judge business risk based on reported earnings.

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