An Analysis of Income Smoothing

Abstract

The purpose of this research is to investigate various income smoothing detection methods.  Using a SEC identified sample of firms that were charged with violations of GAAP due to earnings manipulations and a matched sample of firms, we test seven popular models to determine which provide the best identification of income smoothing. 

The results indicate that, while there is no significant difference between six of the seven detection methods, the Dechow et al. method provides different results. We found the Dechow, et al. method to be significantly different in detecting smoothing, although this method was different only because it detected 25 out of the total of 28 firms as income smoothing firms.  Our results indicate that many more of the matched sample appear to be income smoothing firms and fewer of the SEC sample appear to smooth income.

We think these results indicate that researchers should be cautious in their conclusions.  While these methods provide differing results, they also provide insight into the various aspects of income smoothing and the resulting effect on earnings.  Therefore this research has provided insight into the different income smoothing detection models, while also indicating that different methods are not equally suited to determine all forms of income smoothing.  The appropriate methodology must be chosen to address the specific aspects of income smoothing or earnings management that the researcher is investigating.