Income smoothing and industrial sector Nurfarizan

Introduction Income smoothing has been defined as either the intentional or deliberate dampening of fluctuations about some level of earnings that is currently considered to be normal for a firm (Biedleman, 1973). Kosc (1981) referred income smoothing as a mean used by management to diminish the variability of a stream of reported income numbers relative to some perceived target stream by the manipulation of artificial (accounting) or real (transactional) variables. When income is deliberately or artificially smoothed, inadequate or misleading income disclosure may be the result. Consequently, investors may not get sufficient accurate information about earnings to evaluate the returns and risks of their investments (Ashari et al. 1994). Elias (2002) quoted the former Chairman of the Securities and Exchange Commission (SEC), Arthur Levitt’s speeches in late 1998 as saying that the overall consequences of earnings management, specifically income smoothing is the erosion of trust between shareholders and companies. Levitt also noted that deception is employed to obscure actual financial volatility. Hence, there is a need for financial reporting users, especially investors to understand this phenomenon. Despite the growing body of literature in income smoothing, little attention has been devoted to the relationship between industrial sector and income smoothing making it as interesting topic to be studied. The remainder of this paper is organized as follows. In the next section discuss about prior research on income smoothing practice is held and related studies on relationship between industrial sector, firm size, profitability and ownership structure and develops a number of research hypotheses. This is followed by section outlining the methodology employed, which is followed by results and a discussion of the findings. The conclusion of the study later is drawn in section five. Literature review and hypothesis development Factors effecting income smoothing Previous studies emphasized on the factors associated with income smoothing, such as industrial sector, company size, ownership control, growth, age, nationality, profitability and leverage. Moses (1987) and Wan Ismail et al. found that company size is positively related with income smoothing practices. They concluded that smaller companies were likely to be subjected to less public scrutiny than larger companies. This may be due to the effect of a large company’s performance to the investors, tax authority, creditors, bankers, employees and the public at large. Archibald (1967) suggested that high proportion of companies smoothed their income when their profitability was relatively low. White (1970), Ashari et al. (1994) and Tseng and Lai (2007) also supported the results. Income smoothing activities is also said to be significantly associated with ownership structure. Moses (1987) and Beattie et al. (1994) suggests a negative association between smoothing and the level of managerial ownership. Meanwhile, Wan Ismail et al. (2003), and Kim at al. (2003) documented that the firms that had preceding positive earnings are more likely to manipulate earnings to keep the consecutive earnings growth trend. Industrial sector and income smoothing Previous studies also suggested that companies from different industries smooth income in varying degrees. Companies in different industries face different economical and operational operations that may affect income smoothing ability of the companies and their motivation to smooth income (Atik, 2008). Belkaoui and Picur (1984) studied the effect of dual economy on income smoothing and found that a higher degree of smoothing of income numbers exhibited by firms in the periphery sector than firms in the core sector as a reaction to differences in opportunity structures, experiences, and environmental uncertainty. Firms in the periphery sector face a more restricted opportunity structure and a higher degree of environmental uncertainty than firms in the core sector. According to Belkaoui and Picur (1984), the sectors classification resulted from the creation during the late 19th and early 20th centuries of a core industrial sector dominated by large oligopolistic corporation. The smaller firms and less competitive environment are considered the peripheral sector. However, Albrecht and Richardson (1990) do not found any difference between core and periphery sector as to the incidence