Browsing by Subject "Income Smoothing"

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    Powerful Politicians, Political Costs, and Income Smoothing: Evidence from a Natural Experiment
    (2015-07) Jung, Sumi
    This paper investigates whether and how firms receiving benefits through their connections to politicians use accounting discretion to avoid the cost associated with negative publicity. I use a unique setting that captures the change in political costs arising from chairmanship appointments to influential Senate committees. Appointments to committee chairmanship constitute exogenous shocks, scattered across states and years. Preferential treatment of firms in the home state of a promoted chairman is likely to draw public scrutiny, providing these firms with incentives to dampen large profits by smoothing earnings to reduce potential political backlash. Using a difference-in-difference research design, I find evidence that, following the promotion of their senator, home-state firms smooth their earnings over the years of the chairman's tenure. The smoothing behavior reduces in the period after the chairman vacates the office, consistent with a decline in benefits and the associated political scrutiny. Cross-sectional analysis shows that these effects are stronger for firms expected to receive higher political benefits and consequently higher public scrutiny. Overall, the paper provides evidence of the political cost hypothesis using a comprehensive sample of firms across many years and industries. It highlights the role of political connections in shaping firms' financial reporting strategies.