Income Smoothing and the Cost of Debt
37 Pages Posted: 7 Jun 2010 Last revised: 21 Nov 2017
Date Written: March 10, 2016
Abstract
Existing literature on income smoothing primarily focuses on the effect of earnings smoothing on the equity market. This paper investigates the effect of income smoothing on the debt market. Using the Tucker-Zarowin (TZ) statistic of income smoothing, we find that firms with higher income smoothing rankings exhibit lower cost of debt, suggesting that the information signaling effect of income smoothing dominates the garbling effect. We also find that the effect of earnings smoothing on debt cost reduction is stronger in firms with more opaque information and greater distress risk.
Keywords: Income smoothing, earnings smoothing, garbling, credit spreads, credit ratings, cost of debt
JEL Classification: G12, G32, M41
Suggested Citation: Suggested Citation
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