A well-known stylized fact in the literature is that managers engage in earnings smoothing: they report earnings that are sometimes higher than economic earnings and sometimes lower (see, e.g., Beidleman, 1973; Lev and Kunitzky, 1974; Ronen and Sadan, 1981, Hand, 1989; Barth, Elliott, and Finn, 1999; Goel and Thakor, 2003; Leuz, Nanda, and Wysocki, 2003; Lang, Raedy, and Wilson, 2006; and Myers, Myers, and Skinner, 2007).
Recent survey evidence provides further confirmation that managers actively smooth earnings, as evidenced by a quote from an interviewed CFO: “businesses are much more volatile than what their earnings numbers would suggest” (Graham, Harvey, and Rajgopal, 2005). However, the degree of earnings smoothing varies in the cross section of firms. This has led to research that has uncovered several factors that help explain cross-sectional variations in earnings smoothing.
Earlier studies in insurance demand (e.g., Arrow, 1963; Harris and Raviv, 1978; Holmström, 1979) mostly focus on single (pure) risk and using insurance as the only tool of risk reduction. Later studies (e.g., Gould, 1969; Mayers and Smith, 1983; Briys, 1986, 1988, Gollier, 1994 etc.) then view pure risk as one of the risks in many market risks; thereby, it is nature to derive the insurance decision which is not independent of other financial decisions. Dionne and Doherty (2000) considered several risks, including pure risk, investment risk, background risk and the risk from information asymmetry simultaneously, and pointed out that only insurance policy is not sufficient to manage risks efficiently. Other financial instruments should be jointly used with insurance.
Between May 1989 and November 1991, the prime rate charged by commercial banks dropped from 11.5 percent to 7.5 percent, and the interest rate on large-denomination certificates of deposit fell from around 9 percent to about 5 percent. During this entire period, bank credit card rates barely moved, with the largest issuers holding their rates fixed at 18 to 20 percent.
This recent stickiness of credit card rates repeated a familiar story. During several episodes in the 1980s, when other interest rates rose or fell, credit card rates changed little. At the same time, credit cards consistently earned higher returns than most other bank products. A carefully done study by Ausubel (1991) concludes that during the 1980s, bank credit card operations earned three to five times the rate of return earned in the banking industry at large.
