The academic literature has numerous definitions of earnings quality, yet few of these have theoretical support. For example, while researchers have advanced informal arguments that suggest smoother earnings are “better,” few formal arguments have been made to show when, or if, reporting smoother earnings implies the earnings are more informative or of “higher quality.” This is our research objective.
More specifically, we first characterize equilibrium disclosure strategies for a manager who has better information about the long run value of the firm. We then analyze when, if ever, the manager will be prompted to report higher quality earnings, where we define higher quality earnings as earnings closer to the long run value of the firm.