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The central issue addressed in this study is the actions of
management in the selection of accounting Procedures and
reaction to accounting standards. The corporate managers may be
motivated to smooth their own income with the assumption that
stability in income and rate of growth will be preferred over
higher average income streams with greater variability. It is
important for enternal investors and other public intersts to see
the enterprise as secure; thus, any volatility in financial statement
figures should be smoothed out, and undisclosed reserves should
be set aside in good times and drawn back into income when
times are not as good.
The study also investigate the evidence on the time series
behavior of accounting earnings. The time series of earnings is of
interest because it has implications for hypotheses advanced in
the smoothing literature. The evidence suggests that annual
earnings are well described as a random walk. This result casts
doubt on the Joint hypothesis advanced in the smoothing
literature; The result also suggests that changes in earnings will
have a substantial impact on stock price changes.