An empirical analysis of CEO risk aversion and the propensity to smooth earnings volatility

A. R. Abdel-Khalik

doi:10.1177/0148558X0702200209

An empirical analysis of CEO risk aversion and the propensity to smooth earnings volatility

Research output: Contribution to journal › Article › peer-review

Abstract

Volatility of firm performance is one measure of firm-specific risk that is priced in the marketplace. Because CEOs are typically undiversified investors in their companies' stocks, the negative valuation effects of this risk are asserted to provide them the incentive to reduce earnings volatility. Furthermore, such an incentive is expected to increase in risk aversion. Two alternative measures of risk aversion are generated: one derives from wealth, and the other derives from CEOs' choice of compensation structure as to the risky and safe components. The results consistently show a negative relationship between risk aversion and the volatility of each performance measure: earnings and operating cash flows. The results survived several tests of robustness. However, industry analysis shows that these results do not hold for certain industries such as public utilities.

Original language	English (US)
Pages (from-to)	201-235
Number of pages	35
Journal	Journal of Accounting, Auditing and Finance
Volume	22
Issue number	2
DOIs	https://doi.org/10.1177/0148558X0702200209
State	Published - 2007

Keywords

Earnings volatility
Firm-specific risk
Income smoothing
Management expense preference
Mayshar asset pricing model
Utility over wealth

ASJC Scopus subject areas

Accounting
Finance
Economics, Econometrics and Finance (miscellaneous)

Online availability

10.1177/0148558X0702200209

Library availability

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title = "An empirical analysis of CEO risk aversion and the propensity to smooth earnings volatility",

abstract = "Volatility of firm performance is one measure of firm-specific risk that is priced in the marketplace. Because CEOs are typically undiversified investors in their companies' stocks, the negative valuation effects of this risk are asserted to provide them the incentive to reduce earnings volatility. Furthermore, such an incentive is expected to increase in risk aversion. Two alternative measures of risk aversion are generated: one derives from wealth, and the other derives from CEOs' choice of compensation structure as to the risky and safe components. The results consistently show a negative relationship between risk aversion and the volatility of each performance measure: earnings and operating cash flows. The results survived several tests of robustness. However, industry analysis shows that these results do not hold for certain industries such as public utilities.",

keywords = "Earnings volatility, Firm-specific risk, Income smoothing, Management expense preference, Mayshar asset pricing model, Utility over wealth",

author = "Abdel-Khalik, {A. R.}",

note = "Funding Information: Early drafts of this paper were presented, and greatly benefited from comments, at workshops at the University of Illinois; Pennsylvania State University; Nanyang Technological University; University of New South Wales; Katholic University of Leuven; Washington University mini conference; and Athens University of Business and Economics workshop and the European Accounting Association Congress in Gothenberg in 2005; City University of Hong Kong and The Chinese University of Hong Kong. I benefited by the comments received at those workshop presentations and from Paul Beck, Ying Cao, Dan Collins; John Core, Rajib Doogar, Steven Huddart, Joel Pike, Joshua Ronen, Rachel Schwartz, Theodore Sougiannis, Stephen Taylor, Ken Trotman, T. J. Wong; and Martin Wu. I appreciate the research assistance of Ying Cao, Sam Han, and Keejae Hong and the financial support of the Department of Accountancy at the University of Illinois at Urbana-Champaign.",

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An empirical analysis of CEO risk aversion and the propensity to smooth earnings volatility

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Keywords

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