This study investigates the association between peer effects and earnings smoothing amongst private Italian firms. Previous studies provide compelling evidence that earnings smoothing is common practice amongst privately held European firms. A practice which is also spread amongst private Italian firms. Yet, the underlying assumption of this stream of empirical research is that firms engage in earnings smoothing practice independently of their peers’ choice, despite the extant theoretical literature has been long recognising the important role of mimicking competitors. We provide a bridge between these two streams of research by focusing on a sample of private Italian firms during the period 2014-2019. We adopt a two-stage-least square approach in which peer’s idiosyncratic EBITDA serves as instrumental variable for peers’ earnings smoothing. In line with our expectations built upon the rivalry theory, we document that the association between peers’ effects and earnings smoothing practices is statistically significant and economically meaningful. This result withstands a battery of alternative tests where we adopt different proxies for both earnings smoothing and the set of independent variables of our multivariate analysis. Our findings also confirm the presence of a positive association between earnings smoothing and other factors that are traditionally documented in prior studies: leverage, sales growth, age, absence of prior year losses. Yet, peer effects appear to play a primary role amongst these factors. Overall, our study suggests that when private firms engage in earnings smoothing practices the distorting effects on the quality of financial reporting are not limited to their financial statements, but they worryingly spread over the financial statements of their competitors. Under these circumstances, mimicking peers is a severe obstacle against the representation of a true and fair view, which still represents the goal of financial reporting. This perspective has important implications for regulators and external controls that aim at increasing the level of enforcement of financial reporting rules. And identifying the distinctive features of the most imitated firms becomes fundamental in this respect. Future research can further explore this relation to identify the factors that can mitigate the influence of peers or assess the influence of peers on other reporting practices such as real earnings management.
KEYWORDS: peer effect, earnings smoothing, private firms.
