ABSTRACT:
Against the backcloth of an historical review of the theories that Italian scholars had developed around the role and goals of financial statements, this contribution adopts as theoretical framework the arguments of an intense debate between supporters of two alternative notions of earnings: “realised earnings” based on the concept of “physical” time and “distributable earnings” based on the concept of “economic” time. The final choice in favour of the notion of “realised earnings” – as more aligned with the role of financial statements conceived to convey neutral information to stakeholders – ended the debate and was shared by the dominant doctrine, by the Civil Code and explicitly by Local Italian GAAP. The objective of this analysis is to empirically investigate whether Italian private firms have shared the same view: that is, whether they tend to report in their financial statements the notion of “realised earnings” under the concept of physical time. Based on the financial statements of a large sample of Italian private firms that comply with the Civil Code and Local Italian GAAP, the analysis of the distribution of net earnings and change in net earnings for the period 2004-2017 shows a strikingly high frequency of observations that fall into the region just above zero earnings and consist of very small earnings changes, respectively. This finding suggests the presence of a strong effort towards earnings smoothing: a practice not properly aligned with the notion of “physical” time and “realisable” earnings. This result withstands a battery of alternative tests applied to different profitability measures in order to control for the impact of income tax and extraordinary items, but also to different sub-periods to neutralise the influence of the business cycle. Though this finding does not accord with the result of the doctrinal debate and more worryingly with a strict adherence to the prescriptions of the Civil Law and Italian GAAP, it still is a plausible result in the light of the financial reporting incentives that characterise the setting of private firms. Future research may fruitfully disentangle the role of the specific accruals that are managed to smooth earnings and investigate the role of the main stakeholders that influence this financial reporting behaviour.
KEYWORDS: Realised earnings; smooth earnings; private firm
