Earnings Smoothing, Cash Flow Volatility, and CEO Cash Bonus

Authors


  • Our paper has benefited from the comments and suggestions of Brian Cadman, Harry Evans, James Hansen, Michael Kirschenheiter, Sam Lee, Shail Pandit, Sukesh Patro, Emma Peng, Ram Ramakrishnan, Bonnie Van Ness (editor), an anonymous reviewer, and seminar participants at the University of Illinois at Chicago.

  • Data Availability: All data are available from public databases identified in the paper.

College of Business Administration, University of Illinois at Chicago, 601 S Morgan Street, Chicago, IL 60607; Phone: (312) 996-4482; Fax: (312) 996-4520; E-mail: sdas@uic.edu.

Abstract

Prior studies generally relate managers’ decisions to smooth earnings to their desire to maximize their overall compensation and to smooth their consumption. However, earnings smoothing could also be driven by the firm's expected benefits from reporting a smooth earnings stream. Our paper provides empirical support for the latter explanation of earnings smoothing. Specifically, we find that while CEO bonus on average increases with earnings smoothing, the increase is larger when the firm's cash flow volatility is higher. Further, CEO bonus is shielded from the negative effects of lower earnings arising from the need to report a smoother earnings stream.

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