The Effect of Language on Income Smoothing and on the Informativeness of Earnings: Cross-Country Evidence

Abstract

Using income smoothing and its two components – the informational component and the garbled component – we examine whether and how the time-oriented tendency embedded in languages influences corporate financial reporting decisions. Separating languages into weak- versus strong- future time reference (FTR) groups, we find that firms in weak-FTR countries tend to smooth earnings more. We also find that the informational component, rather than the garbled component, of income smoothing is stronger for firms in weak-FTR countries, indicating that income smoothing in weak-FTR countries enhances the informativeness of corporate earnings. These results are consistent with the ‘linguistically-induced bias in time perception’ mechanism of FTR, which suggests that language affects management’s future-related choices by changing how distant future events feel. Taken together, these findings provide new insights into how language influences corporate financial reporting decisions and the informativeness of earnings.