Do Creditors Prefer Smooth Earnings? Evidence from European Private Firms

ABSTRACT

We investigate the interplay between creditor financing and the smoothness of earnings reported by European private firms, and document how heterogeneous debt-contracting infrastructures across Europe moderate this relation. We expect the smoothness of earnings to be positively related to the relative importance of credit providers in our setting. More importantly, we predict this relation to be more pronounced in regimes with higher bankruptcy and contract enforcement costs. Finally, we hypothesize that earnings smoothness is negatively related to the cost of debt of our sample firms. Our large-sample empirical evidence confirms our expectations. While the cross-sectional nature of our setting limits our potential to address endogeneity concerns and, thus, caution is required when interpreting our findings in a causal way, they are consistent with the accounting of European private firms being shaped by creditor incentives and with this link being moderated by the country-level efficiency of the debt-contracting infrastructure.

Keywords: earnings smoothness, debt contracting, cost of debt, European private firms

Article Citation:

Joachim Gassen and Rolf Uwe Fülbier (2015) Do Creditors Prefer Smooth Earnings? Evidence from European Private Firms. Journal of International Accounting Research: Fall, Vol. 14, No. 2, pp. 151-180.