This paper examines the conditional association between earnings smoothing via discretionary accruals and firms’ credit quality and value. We argue that the information environment is important in how the market assesses earnings smoothing. We construct a smoothing index that measures the impact on reported earnings per share volatility from the use of accounting discretion. We find confirming evidence of a stronger association between discretionary earnings smoothing and firms’ cost of debt and Tobin's Q when the information environment for the firm is weaker. We also document that during the pre-Reg FD period smoothing firms with a low information environment appear more systematic, suggesting that managers of more opaque firms are more able to capture hidden cash flows when using accounting discretion to smooth earnings.

The balance sheet accumulates the effects of previous accounting choices, so the level of net assets partly reflects the extent of previous earnings management. We predict that managers' ability to optimistically bias earnings decreases with the extent to which the balance sheet overstates net assets relative to a neutral application of GAAP. To test this prediction, we examine the likelihood of reporting various earnings surprises for 3,649 firms during 1993–1999. Consistent with our prediction, we find that the likelihood of reporting larger positive or smaller negative earnings surprises decreases with our proxy for overstated net asset values.

Ross Jennings, Paul J. Simko, Robert B. Thompson II, Does LIFO Inventory Accounting Improve the Income Statement at the Expense of the Balance Sheet?, Journal of Accounting Research, Vol. 34, No. 1 (Spring, 1996), pp. 85-109

This paper examines the conditions under which the market responds to disclosures of significant increases in short selling, and whether proxies for earnings expectations and alternative information sources help explain this response. Our sample is based on firms that experience abnormal short interest increases (“short spikes”) during 1989–1998. We find that the mean abnormal return around short spike announcements is significantly more negative for firms with low analyst following, consistent with short sellers providing perceived value when there are limited alternative sources of guidance available. For firms with high analyst following we find the market response is dependent on earnings levels, consistent with investors viewing a short interest increase as providing information about the sustainability of earnings. Additional analyses reveal that these inferences are not affected by measures of firms' earnings quality or by the relative size of the short spike. We infer from our analyses that the information content of short interest disclosures is conditional on both the firms' existing information environment and expectations of future performance as conveyed by prior earnings. This inference is consistent with short sellers' role as information intermediaries covering the lower tail of earnings expectations.

Analysts, Analysts reports, Investor behavior