The Informational Role of Earnings Smoothing in Diversification

Abstract

This paper examines whether managers smooth earnings to affect information asymmetry upon diversification. Using a sample of firms listed in Taiwan Stock Exchange, the results show that earnings smoothing increases the positive association between industrial diversification and bid-ask spread but reduces the negative association between global diversification and bid-ask spread. Our results are robust with respect to alternative research methodology (3SLS), alternative proxy for information asymmetry (analyst following), refined measure of earnings smoothing (i.e., discretionary earnings smoothing) after controlling for leverage, negative earnings, and return on equity. Collectively, the evidence suggests that discretionary earnings smoothing conveys managers’ favorable information for firms with global diversification, but garbles managers’ unfavorable information for firms with industrial diversification.