Earnings Volatility, Cash Flow Volatility, and Informed Trading

Sudarshan Jayaraman

209 citations0/0 files storedJournal of Accounting Research

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Auditing, Earnings Management, Governance Financial Markets and Investment Strategies Corporate Finance and Governance

Abstract

ABSTRACT I examine whether earnings that are smoother or more volatile than cash flows provide or garble information. Consistent with theories that predict more informed trading when public information is less informative, I find that bid‐ask spreads and the probability of informed trading are higher both when earnings are smoother than cash flows and also when earnings are more volatile than cash flows. Additional tests suggest that managers' discretionary choices that lead to smoother or more volatile earnings than cash flows garble information, on average. However, I find that informed trading is attenuated in settings in which theory suggests that discretionary smoothing or volatizing of earnings is likely to be informative.

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References

1976Theory of the firm: Managerial behavior, agency costs and ownership structure 2002Illiquidity and stock returns: cross-section and time-series effects 1985Continuous Auctions and Insider Trading 1991Earnings Management During Import Relief Investigations 1995Detecting Earnings Management.2005The economic implications of corporate financial reporting 1985Bid, ask and transaction prices in a specialist market with heterogeneously informed traders 2003Earnings management and investor protection: an international comparison

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