What is Net Income

The literature suggests that firms are actively managing the smoothing of their reported positive net incomes. The observed frequency of second digits abnormally exceeds the level predicted by Benford's Law, which results in a higher frequency of the number zero and an abnormally low occurrence of the number nine in the second digit of the reported income numbers. A reversal pattern occurs for reported net losses. This phenomenon is typically peculiar to countries with weak governance and firms under pressure to meet analysts' expectations. This chapter examines 10 years of reported net incomes by 5,040 firms (44,636 firm-years) in 10 countries ranked as having the best corporate governance quality. The analysis reveals that firms in these countries were not spared from opportunistically rounding their earning numbers. In fact, this rounding behavior is more prevalent when net losses were reported and this rounding phenomenon co-varied with some institutional factors; in particular, the rule of law and government effectiveness has significantly influenced the rounding behavior.