Accruals, Income Smoothing and Bond Ratings

41 Pages Posted: 11 Mar 2006

See all articles by Zhaoyang Gu

Zhaoyang Gu

Chinese University of Hong Kong - School of Accountancy

Yinqing Zhao

Carnegie Mellon University

Date Written: March 2006

Abstract

We examine the role of accounting accruals in bond ratings in this paper. Accruals provide information about firms' future performance not only through their effects on the levels but also the volatility of reported earnings. We show that bond ratings are significantly related to accruals and their income-smoothing effect. Relative to cash flows, accrual-based earnings either in levels or in volatility dominate cash flows in explaining bond ratings. Incremental to cash flows, accruals that are higher or make income smoother are associated with more favorable bond ratings. Accruals also receive larger weight in bond ratings when they serve the income-smoothing function. Finally, we show that accrual management may not be responsible for the over-time downward trend in bond ratings.

Keywords: income smoothing, accruals, cash flows, bond ratings

JEL Classification: G10, G12, M40, M41

Suggested Citation

Gu, Zhaoyang and Zhao, Yinqing, Accruals, Income Smoothing and Bond Ratings (March 2006). Available at SSRN: https://ssrn.com/abstract=817506 or http://dx.doi.org/10.2139/ssrn.817506

Zhaoyang Gu (Contact Author)

Chinese University of Hong Kong - School of Accountancy ( email )

Shatin, N.T.
Hong Kong

Yinqing Zhao

Carnegie Mellon University ( email )

Pittsburgh, PA 15213-3890
United States

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