Net income smoothing and risk transfer to stakeholders: Empirical evidence in Europe

This study presents a general framework to empirically test the dynamics of risk transfer at the level of the firm to its internal and external stakeholders. Building on a large sample of European companies, we argue that this risk transfer occurs through net income smoothing. Accordingly, we resort to various smoothing measures to identify through which channels, referred to as “risk smoothing channels”, the cross-sectional variance in sales is transferred to the firm’s stakeholders. The empirical analysis reveals that net income stabilization can be viewed from a dual perspective: from the stakeholder perspective as the downside and upside risk driver; from the shareholder perspective as an opportunity cost to maintain as much as possible stable expectations of firm’s performance. Thus, shareholders appear to exhibit a sort of stable and ex-ante contracted profit, net of the component associated with market volatility. Conversely, stakeholders bear a risk that resembles that normally associated with financial investors both in terms of symmetrical manifestation and risk-return trade-off. The income variance decomposition is further analyzed in a wider intertemporal, sectoral and spatial perspective. Ultimately, the results obtained can serve as input for expanding corporate governance studies, incorporating the dynamics of risk transfer between a firm and its internal and external stakeholders.