The Effect of Earnings Smoothing on Investment Efficiency

[Purpose] This research aims to investigate the economic role of earnings smoothing by examining whether earnings smoothing can improve investment efficiency by mitigating mispricing on investment sensitivity and Management performance. Additionally, the study validates whether earnings smoothing has a differential impact on investment sensitivity depending on financial constraints. [Methodology] Using a firm－year sample of 4,441 non－financial companies listed on the KOSPI and KOSDAQ markets, the effect of earnings smoothing on investment efficiency is analyzed through a regression model. [Findings] The main empirical analysis results are as follows. First, companies tend to expand(contract) their investments in response to overvaluation (undervaluation) of firm value. However, earnings smoothing has been found to improve investment efficiency. Second, earnings smoothing contributes to improving management performance. Finally the effect of earnings smoothing is differentiated depending on financial constraints. [Implications]This study analyzes the information effect of earnings smoothing on investment efficiency and management performance. It also provides empirical evidence on the differential economic effects of earnings smoothing based on financial constraints.