Managerial ownership-induced income smoothing and information asymmetry

Purpose – The purpose of this paper is to examine whether managerial ownership-induced income smoothing accentuates or attenuates an information asymmetry problem. Standard agency theory suggests that managerial ownership may play a significant role in alleviating agency problems between managers and external shareholders that can arise from information asymmetry. According to this view, managerial ownership-induced income smoothing could convey managerial private information and could, therefore, be considered as informative. However, managerial ownership could also entrench managers with absolute control of firms, and encourage them to engage in earnings manipulation, including earnings smoothing, in order to hide private benefits of control.

Design/methodology/approach – The paper uses two smoothing measures, and separate total smoothing into its innate and discretionary components. The former is determined by firm fundamentals, whereas discretionary smoothing allows managers the flexibility to use it for either informative or opportunistic reasons. The paper then regresses information asymmetry, as proxied by scaled bid-ask-spreads, on the interaction between managerial ownership and both these smoothing components. 

Findings – The paper documents that managerial ownership-induced discretionary smoothing has a positive effect on bid-ask spreads. This result seems to support the entrenchment view of managerial ownership.

Practical implications – This study offers insights to policy makers interested in enhancing the effectiveness of the managerial ownership aspect of corporate governance in New Zealand.

Originality/value – This paper uses agency theory to provide a comparative assessment of the efficient versus the entrenchment hypotheses with respect to managerial ownership.