Is the Contribution of Fundamental Analysis Affected by the Firms’ Income Smoothing?

This paper examines whether the types of firms’ income smoothing influences the usefulness of fundamental analysis in Korea. Prior literature points out that the fundamental signals have predictive power for future earnings and also argue that fundamental signals are complements when the earnings loses value relevance. In this paper, we examine whether the fundamental signals have predictive power in Korea and also its information content is more useful when earnings lose its predictive power. We divide our sample as the firms engaging in income smoothing for disseminating information to the investors or for getting manager’s own benefits. Consistent with our hypothesis, we find that fundamental signals have predictive power and also we find that fundamental signals’ information content is strengthened when the earnings predictability is decreased. These findings suggest that fundamental signals are complementing current earnings changes.