Institutional Ownership, Business Cycles and Earnings Informativeness of Income Smoothing: Evidence from Iran

Document Type: Research Paper

Authors

1 Faculty of Management and Accounting, Farabi Campus, University of Tehran, Qom, Iran

2 Faculty of Management and Accounting, Farabi Campus, University of Tehran, Qom, Iran.

3 The University of Shahab Danesh, Qom, Iran

4 Faculty of Management and Accounting, University of Qom, Qom, Iran

10.22034/amfa.2020.1892989.1374

Abstract

Managers engage in income smoothing either to communicate private information about future earnings to investors (informativeness hypothesis) or to distort financial performance for opportunistic purposes (opportunism hypothesis). Business cycles and the monitoring role of institutional ownership may affect the earnings informativeness of income smoothing. The purpose of this research is to examine the effect of business cycles and institutional ownership on the earnings informativeness of income smoothing. 140 firms listed on the Tehran Stock Exchange are selected as the sample over the period 2010-2016. The results showed that, during recession, income smoothing does not effectively communicate information about future earnings and thus earnings are less informative. Moreover, higher levels of institutional ownership are associated with a decrease in their monitoring role and decrease in the earnings informativeness of income smoothing. Finally, the results suggested that the relationship between institutional ownership and the earnings informativeness of income smoothing is not significantly affected by business cycles.

Keywords


[1] Alavi Tabari, H., Rajabi, R., and Shahbazi, M., The relationship between corporate governance and external auditors’ audit fee, Iranian Journal of Accounting, 2011, 2(5), P. 75-101. (in Persian).

[2] Al-Najjar, B., and Taylor, P., The relationship between capital structure and ownership structure: New evidence from Jordanian panel data, Managerial Finance, 2008, 34(12), P. 919-933. Doi: 10.1108/03074350810915851.

[3] Arya, A., Glover, J., and Sunder, S., Earnings management and the revelation principle, Review of Accounting Studies, 1998, 3(1-2), P. 7-34.  Doi: 10.1023/A:1009631714430.

[4] Bhide, A., The hidden costs of stock market liquidity, Journal of Financial Economics, 1993, 34(1), P. 31-51.  Doi: 10.1016/0304-405X(93)90039-E.

[5] Black, B. S., Agent watching agents: The promise of institutional investor voice, UCLA Law Review,1992, 39, P. 811-893.

[6] Bowman, E. H., Risk seeking by troubled firms, Sloan Management Review, 1982, 23(4), P. 33-42.

[7] Brous, P., and Kini, O., The valuation effects of equity issues and the level of institutional ownership: Evidence from analysts’ earnings forecasts, Financial Management, 1994, 23(1), P. 33-46. Doi: 10.2307/3666054.

[8] Burns, A. F., and Mitchell, W. C., Measuring Business Cycles, NBER Books. 1946.

[9] Bushee, B., The influence of institutional investors on myopic R&D investment behavior, The Accounting Review, 1998, 73(3), P. 305-333.

[10] Bushee, B., Do institutional investors prefer near-term earnings over long-run value? Contemporary Accounting Research, 2001, 18(2), P. 207-246.  Doi: 10.1506/J4GU-BHWH-8HME-LE0X,

[11] Chen, C. L., Weng, P. Y., and Lin, Y. C., Global Financial Crisis, Institutional Ownership, and the Earnings Informativeness of Income Smoothing, Journal of Accounting, Auditing & Finance, 2017, 35(1), P. 53–78.  Doi: 10.1177/0148558X17696759.

[12] Choi, J. H., Kim, J. B., and Lee, J. J., Value relevance of discretionary accruals in the Asian financial crisis of 1997-1998, Journal of Accounting and Public Policy, 2011,30(2), P. 166-187.  Doi: 10.1016/j.jaccpubpol.2010.09.002.

[13] Collins, D.W.,  Kothari, S.P., Shanken, J., and Sloane, R. G., Lack of timeliness and noise as explanations for the low contemporaneous return-earnings association, Journal of Accounting and Economics, 1994, 18(3), P. 289-324.  Doi: 10.1016/0165-4101(94)90024-8.

[14] DeFond, M. L., and Park, C. W., Smoothing income in anticipation of future earnings, Journal of Accounting & Economics, 1997, 23(2), P. 115-139.  Doi: 10.1016/S0165-4101(97)00004-9.

[15] Deng, S., Elyasiani, E., and Jia, J., Institutional ownership, diversification, and riskiness of bank holding companies, Financial Review, 2013, 48(3), P. 385-415.  Doi: 10.1111/fire.12008.

[16] Earnhart, D., and Lizal, L., Effects of Ownership and Financial Performance on Corporate Environmental Performance, Journal of Comparative Economics, 2006, 34(1), P. 111-129.  Doi: 10.1016/j.jce.2005.11.007.

[17] Faraji, O., Kashanipour, M., MohammadRezaei, F., Ahmed, K., Vatanparast, N., Political connections, political cycles and stock returns: Evidence from Iran, Emerging Markets Review, 2020 Nov 2:100766 in press. Doi: 10.1016/j.ememar.2020.100766

[18] Fudenberg, D., and Tirole, J., A theory of income and dividend smoothing based on incumbency rents, Journal of Political Economy, 1995, 103(1), P. 75-93.  Doi: 10.1086/261976.

[19] Graham, J. R., Harvey, C. R., and Rajgopal, S., The economic implications of corporate financial reporting, Journal of Accounting & Economics, 2005, 40(1-3), P. 3-73.  Doi: 10.1016/j.jacceco.2005.01.002.

[20] Hadian, E., and Hashempour, M., Business cycles in Iran’s economy, Iranian Journal of Economics Research, 2003, 5(15), P. 93-120(in Persian).  

[21] Hashemi, A., and Samadi, V., Effect of income smoothing on the information content of earnings in firms listed on the Tehran Exchange, Iranian Journal of Accounting Research, 2009, 1(1), P. 148-167. (in Persian).   

[22] Healy, P. M., The effect of bonus schemes on accounting decisions, Journal of Accounting & Economics, 1985, 7(1-3), P. 85-107.

[23] Hepworth S.R., Smoothing periodic income, The Accounting Review,1953, 28(1), P.  32-39.

[24] Ivashina, V., and Scharfstein, D., Bank lending during the financial crisis of 2008, Journal of Financial Economics, 2010, 97(3), P. 319-338.  Doi: 10.1016/j.jfineco.2009.12.001,

[25] Jiambalvo, J., Rajgopal, S., and Venkatachalam, M., Institutional ownership and the extent to which stock prices reflect future earnings, Contemporary Accounting Research, 2002, 19(1), P. 117-146.  Doi: 10.1506/EQUA-NVJ9-E712-UKBJ.

[26] Karami, G., and Eftekhari, V., A study of certain measures of accounting earnings quality across business cycles, Iranian Journal of Accounting and Auditing Research, 2013, 20(4), P. 93-112. (in Persian).

[27] Khodamipour, A., Karamshahi, B., and Taftian, A., Conservatism, value relevance, and business cycles, Iranian Journal of Financial Accounting Research, 2012, 4(13), P. 71-86 (in Persian).

[28] Kim, J. B., and Yi, C. H., Ownership structure, business group affiliation, listing status, and earnings management: Evidence from Korea, Contemporary Accounting Research, 2006, 23(2), P. 427-464.  Doi: 10.1506/7T5B-72FV-MHJV-E697.

[29] Koh, P., Institutional investor type, earnings management and benchmark beaters, Journal of Accounting and Public Policy, 2007, 26(3), P. 267-299.  Doi: 10.1016/j.jacceco.2004.11.002.

[30] Kothari, S. P., Leone, A. J., and Wasley, C. E., Performance matched discretionary accruals measures, Journal of Accounting & Economics, 2005, 39(1), P. 161-197. Doi: 10.1016/j.jacceco.2004.11.002.

[31] Kumar, J., Does ownership structure influence firm value? Evidence from India, The Journal of Entrepreneurial Finance and Business Ventures, 2003, 9(2), P. 61-93.  Doi: 10.2139/ssrn.464521.

[32]  Mashayekhi, B., and Mashayekh, S., Development of accounting in Iran, International Journal of Accounting, 2008, 43(1), P. 66-86.  Doi: 10.1016/j.intacc.2008.01.004.

[33] Matsumoto, D. A., Management's incentives to avoid negative earnings surprises, The Accounting Review, 2002, 77 (3), P. 483-514.  Doi: 10.2308/accr.2002.77.3.483.

[34] Mehrabanpour, M., Faraji, O., Sajadpour, R., Alipour, M., Financial statement comparability and cash holdings: the mediating role of disclosure quality and financing constraints, Journal of Financial Reporting and Accounting, 2020, 18(3), P. 615-637.  Doi:10.1108/JFRA-12-2019-0167

[35] Mehrani, S., Faal, A., and Moradi, M., The relationship between institutional ownership and value relevance of accounting information, Iranian Journal of Accounting, 2012, 3(11), P. 31-55. (in Persian).

[36] Mohammadrezaei, F., and Mohd-Saleh, N., Audit report lag: The role of auditor type and increased competition in the audit market, Accounting and Finance, 2018, 58(3), P. 885-920.  Doi: 10.1111/acfi.12237.

[37] Mohammadrezaei, F., Faraji, O., Heidary, Z., Audit partner quality, audit opinions and restatements: evidence from Iran, International Journal of Disclosure and Governance, 2020 in press, Doi: 10.1057/s41310-020-00083-0.

[38] Mohammadrezaei, F., Faraji, O., The dilemma of audit quality measuring in archival studies: critiques and suggestions for Iran’s research setting, Journal of Accounting and Auditing Review, 2019, 26(1), P. 87-122. Doi: 10.22059/ACCTGREV.2018.256781.1007884(in Persian).  

[39] Mohammadrezaei, F., Mohd-Saleh, N., and Banimahd, B., Political economy of corporate governance: the case of Iran, International Journal of Business, Governance and Ethics, 2012, 7(4), P. 301-330. Doi: 10.1504/IJBGE.2012.051225.

[40] Mohammadrezaei, F., Mohd-Saleh, N., Jaffar, R. and Hassan, M. S., The effects of audit market liberalization and auditor type on audit opinions: The Iranian experience, International Journal of Auditing, 2016, 20(1), P. 87-100.  Doi: 10.1111/ijau.12059.

[41] Nazemi, A., Momtazian, A., and Behpur, S., Investigating the Relationship between Disclosure Quality and Stock Return of the Companies Listed in Tehran Stock Exchange: Using a Simultaneous Equations System, Journal of Accounting Advances, 2016, 7(2), P. 219-244.(in Persian).

[42] Petersen, M.A., Estimating standard errors in finance panel data sets: comparing approaches,  The Review of Financial Studies, 2009, 22(1), P. 435-480.  Doi: 10.1093/rfs/hhn053.

[43] Porter, M. E., Capital Choices: Changing the Way America Invests in Industry, Washington, DC: Council on Competitiveness, 1992.  Doi: 10.1111/j.1745-6622.1992.tb00485.x.

[44] Ramalingegowda, S., and Yu, Y., Institutional ownership and conservatism, Journal of Accounting & Economics, 2012, 53(1), P. 98-114.  Doi: 10.1016/j.jacceco.2011.06.004.

[45] Rezaee, Z., Alipour, M., Faraji, O., Ghanbari, M., Jamshidinavid, B., Environmental disclosure quality and risk: the moderating effect of corporate governance, Sustainability Accounting, Management and Policy Journal, 2020, Jun 10 in press. Doi: 10.1108/SAMPJ-10-2018-0269

[46] Sadka, R., Liquidity risk and accounting information, Journal of Accounting & Economics, 2011, 52(2), P. 144-152.  Doi: 10.1016/j.jacceco.2011.08.007.

[47] Solomon, J., and Solomon, A., Corporate Governance and Accountability, England, John Wiley & Sons, LTD, 2005.

[48] Tucker, J. W., and Zarowin, P. A., Does income smoothing improve earnings informativeness? The Accounting Review, 2006, 81(1), P. 251-270.  Doi: 10.2308/accr.2006.81.1.251.

[49] Tavana, M., Izadikhah, M., Di Caprio, D., Farzipoor Saen, R., A new dynamic range directional measure for two-stage data envelopment analysis models with negative data, Computers & Industrial Engineering, 2018, 115, P. 427-448, Doi: 10.1016/j.cie.2017.11.024

[50] Velury, U., and Jenkins, D. S., Institutional ownership and the quality of earnings, Journal of Business Research, 2006, 59(9), P. 1043-1051.  Doi: 10.1016/j.jbusres.2006.05.001.

[51] Watts, R. L., and Zimmerman, J. L., Positive accounting theory: A ten year perspective, The Accounting Review, 1990, 65(1), P. 131-156.

[52] Yan, S., and Zhang, Z., Institutional investors and equity returns: Are short-term institutions better informed? Review of Financial Studies,  2009, 22(2), P. 893-924. Doi: 10.1093/revfin/hhl046.

[53] Zhong, Y., Li, W., and Li, Y., Discretionary income smoothing and crash risk: evidence from China, Asia-Pacific Journal of Accounting & Economics, 2019, 48, P. 1-23. Doi: 10.1080/16081625.2019.1600413.