Is labor related to the duality of earnings smoothing?

Abstract

Previous accounting studies indicate that union strength is positively related to income smoothing and that management is more likely to smooth income when labor power is strong. Researchers debate about whether income smoothing has either a garbling or an informative role. This paper investigates the cross-country impact of labor power on the extent to which information about future prospects is efficiently communicated through income smoothing. It proposes that strong labor power will garble income smoothing, which means that the efficient communication of private information is constrained in strong labor protection settings. Consistent with our predictions, the results show that the informative role of income smoothing is restricted with strong labor protection after controlling for legal institutions, financial-market development, and economic wealth. This study provides new insights into the role of income smoothing by inspecting the linkage between labor protection and income smoothing.