Income Smoothing through R&D Management and Earnings Informativeness

Abstract

We examine whether income smoothing via R&D management is associated with more informative earnings. While the literature finds earnings smoothing through accruals improves earnings informativeness, it is unclear whether smoothing through R&D management is used to inform investors because R&D management is relatively more difficult to detect and curb. We find that R&D management, which represents a subset of real activities management, is associated with more informative earnings, but the association is weaker relative to smoothing through accruals. We also document that R&D-based smoothing is associated with more accurate and less disperse analyst forecasts of earnings, but the association is weaker relative to smoothing through accruals. Overall, we provide novel evidence suggesting that managers use R&D management to smooth temporary shocks to earnings and inform investors.