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Accounting conservatism, financial reporting and stock returns
Abstract
Research Question: One of the aims of this paper is to examine accounting conservatism using a robust set of data collected from the recent years to better understand how accounting conservatism affects the relations between stock returns and accounting variables. Motivation: Financial reporting is increasingly dependent on an in-depth understanding of the imperfections in the capital markets as well as the impact of the accounting standards on firm performance. Idea: The effect of accounting regulations on the firms’ reporting practices can be evaluated via a firm’s change in cash investments and its operating assets. Data: This study employs a robust set of data with different market to book ratios and corporate governance characteristics collected from Compustat North America Fundamentals Annual firm year observations for the time period of January 1998 to December 2015 fiscal years to better understand how accounting conservatism affects the relations between stock returns and accounting variables. Tools: Compared to the previous studies, any potential improvement in the research method is provided using a regression weight averaged over the years. Findings: There is an improvement in the explanatory power of the estimates of the coefficients on earnings levels and earnings changes when the variables associated with accounting conservatism are incorporated in the analysis. Contribution: Given the ample amount of research done in the international aspects of financial reporting, analyses of differences in results compared to the previous studies and future research opportunities will be provided.
... Under this principle, a manager has the option to recognize a loss or gain in the financial statements depending on the occurrence of a future event. Conservatism provides information about an unpleasant situation that may cause the firm to incur loss and not about a situation that may lead to gain (Xia et al., 2019;Ewert & Wagenhofer, 2012). As such, the application of conservatism may lead to the non-disclosure of relevant information in financial reports. ...
... Nevertheless, several studies (Lara et al., 2020;Xia et al., 2019;Kim & Zhang, 2016) reported that conservatism is a characteristic of high earnings quality. For instance, Xia et al. (2019) argued that conservatism reduces opportunistic management behavior. ...
... Nevertheless, several studies (Lara et al., 2020;Xia et al., 2019;Kim & Zhang, 2016) reported that conservatism is a characteristic of high earnings quality. For instance, Xia et al. (2019) argued that conservatism reduces opportunistic management behavior. Likewise, Dai and Ngo (2020), and Ahmed and Duellman (2011) argued that conservatism enhances corporate governance since it reduces agency problems in an investment decision. ...
Purpose: During unstable economic conditions, investors are risk averse and rely on fundamental information such as accounting information to make investment decisions. It is reported that during the COVID-19 pandemic, businesses have used accounting discretion in order to cope with difficult economic conditions. The use of discretion in the accounting process may instigate earnings manipulations which reduce earnings quality. This raises the following research question: has earnings quality decreased during the COVID-19 pandemic? This paper aimed at examining earnings quality (EQ) of South African listed firms during the COVID-19 pandemic. Specifically, the study examined the EQ of these firms before and during the COVID-19 pandemic. Methodology: Weighted least square regression was used to analyze a sample of 132 non-financial firms listed on the Johannesburg Stock Exchange (JSE) over the period of 2018 to 2021. The sampled firms were extracted from the IRESS research domain. Conservatism and accrual quality were used to measure earnings quality because these two measures required the exercise of discretion. Findings: The results attained were mixed and suggested that, although the sampled firms did not apply accounting conservatism in reported earnings during the COVID-19 pandemic period as compared to the period before the pandemic, there is no evidence of the use of accrual quality to manipulate earnings during the pandemic period as compared to the period before the pandemic. Originality/Value: The paper will shed light on whether accounting information remains reliable during unstable economic conditions. In addition, it will inform regulators on whether the accounting standards were consistently applied during the COVID-19 pandemic.
... Do đó, thận trọng được coi là một thuộc tính của BCTC chất lượng cao theo nguyên tắc không báo cáo quá cao các khoản doanh thu/thu nhập, nhưng không báo cáo quá thấp các khoản chi phí/tổn thất có thể xảy ra. Nhiều nhà NC đã thừa nhận lợi ích của KT thận trọng trong việc cải thiện CLTT lợi nhuận KT (Asri, 2017; Xia et al., 2019). Trên thực tế, KT thận trọng thu hẹp sự bất cân xứng thông tin giữa các bên trong các mối quan hệ hợp đồng (Zadeh et al., 2022) và buộc các nhà quản lý phải báo cáo tin xấu một cách kịp thời, từ đó giảm hành vi thao túng lợi nhuận (García Lara et al., 2020). ...
Bài viết nghiên cứu chất lượng thông tin lợi nhuận kế toán (KT) của các DNNY trên thị trường chứng khoán Việt Nam trong thời kỳ Covid-19 với mẫu gồm 600 quan sát của 100 DN phi tài chính trên HSX giai đoạn 2017-2022. Mức độ thận trọng có điều kiện và độ lớn của khoản dồn tích tùy ý được dùng để đo lường chất lượng thông tin lợi nhuận KT. Kết quả hồi quy cho thấy: (1) các công ty đã tăng mức độ thận trọng trong thời kỳ đại dịch để bảo vệ lợi ích của các nhà đầu tư và bên cho vay; (2) không có bằng chứng cho rằng các công ty tăng cường sử dụng khoản dồn tích tùy ý để thao túng lợi nhuận trong đại dịch. Bài viết chứng tỏ chất lượng thông tin lợi nhuận KT của các DNNY Việt Nam vẫn được duy trì và không bị tác động tiêu cực bởi đại dịch. Nghiên cứu (NC) đã đưa ra bằng chứng thực nghiệm thuyết phục cho các tổ chức tư vấn, nhà đầu tư và người sử dụng thông tin để đánh giá chất lượng thông tin lợi nhuận KTDN trong bối cảnh đặc biệt của nền kinh tế. Đồng thời, bài viết cũng gợi mở hàm ý chính sách với cơ quan quản lý về sự cần thiết của việc ban hành các hướng dẫn KT cho DN trong trường hợp chưa có tiền lệ như Covid-19.
... Earnings conservatism facilitates efficient contracting between mangers and shareholders in the existence of agency problems and can effectively reduce market uncertainly, information asymmetry (Ahmed and Duellman, 2007;Lafond and Roychowdhury, 2008;LaFond and Watts, 2008), information risk (Kravet and Shevlin, 2010), bankruptcy risk (Biddle et al., 2020), financial reporting credibility (Francis et al., 2004) and litigation risk (Watts, 2003a, b;Ruch and Taylor, 2015). Moreover, earnings conservatism is an efficient financial reporting mechanism in the absence of contracting, which constrains managers' opportunistic behavior and thus can assure reliable financial disclosure (Watt, 2003a, b;Ahmed and Duellman, 2007;Lafond and Roychowdhury, 2008;LaFond and Watts, 2008;Zhong and Li, 2017;Xia et al., 2019). ...
Purpose: Based on signal theory and legitimacy theory, this paper examines whether firms with financial reporting misstatements (restatements) would prefer conservative financial reporting to send signals regarding their determinants of improving financial reporting credibility and legitimate organizational image in Taiwan. This paper further examines whether these firms reduce the demand for conservative financial reporting after replacing managers in the reveal of restatements.
استهدفت هذه الدراسة اختبار أثر التحفظ المحاسبي على قرار الشركة بإعادة شراء أسهمها (أسهم الخزينة) وذلك بالنسبة للشركات المدرجة في سوق الأوراق المالية المصري. وقد تم اشتقاق فرض البحث في صورته البديلة والذي يتمثل في: يؤثر التحفظ المحاسبي تأثيراً معنوياً سلبياً على قرار الشركة بإعادة شراء أسهمها وذلك بالنسبة للشركات المدرجة في سوق الأوراق المالية المصري. وتم استخدام أسلوب الانحدار المتعدد وأسلوب الإنحدار اللوجيستي في اختبار فرض الدراسة، حيث تكونت عينة الدراسة من 24 شركة من الشركات المدرجة في سوق الأوراق المالية المصري بعد استبعاد البنوك وشركات التأمين، وذلك خلال الفترة من عام 2000 إلى عام 2019. وقد تم تقسيم عينة الدراسة الى مجموعتين وفقاً للطريقة المُستخدمة في قياس المتغير التابع (قرار الشركة بإعادة شراء أسهمها). وقد بلغ عدد المشاهدات في المجموعة الأولى 64 مشاهدة، وهي المجموعة المرتبطة بقياس قرار الشركة بإعادة شراء أسهمها عن طريق قياس نسبة أسهم الخزينة الفعلية (عدد أسهم الخزينة مقسوماً على إجمالي عدد الأسهم للشركة)، بينما بلغ عدد المشاهدات في المجموعة الثانية 480 مشاهدة، وهي المجموعة المرتبطة بقياس قرار الشركة بإعادة شراء أسهمها عن طريق اعطاء القيمة 1 للشركات التي قامت بالإفصاح عن أسهم الخزينة في قائمة المركز المالي ضمن حقوق الملكية، واعطاء القيمة صفر للشركات التي لم تفصح عن أسهم الخزينة( لم تقم بإعادة شراء أسهمها).
وتتمثل المساهمة العلمية لهذه الدراسة في قيام الباحث بصياغة نموذج جديد لدراسة أثر التحفظ المحاسبي على قرار الشركة بإعادة شراء أسهمها وذلك بالنسبة للشركات المدرجة في سوق الأوراق المالية المصري. وعلى حد علم الباحث، توجد ندرة في الدراسات السابقة التي قامت بدراسة هذا الأثر السابق ذكره أعلاه في جميع دول العالم بصفة عامة، وفي جمهورية مصر العربية بصفة خاصة، وبالتالي، تتمثل المساهمة العلمية لهذه الدراسة في إجرائها في البيئة المصرية. وقد توصل الباحث إلى أنه يؤثر التحفظ المحاسبي تأثيراً معنوياً سلبياً على قرار الشركة بإعادة شراء أسهمها وذلك بالنسبة للشركات المدرجة في سوق الأوراق المالية المصري.
الكلمات المفتاحية: التحفظ المحاسبي، قرار الشركة بإعادة شراء أسهمها، أسهم الخزينة.
In recent years, large data analysis methods have been widely used in many fields. For example, it can be applied to environmental art design, computer technology application and so on. More and more companies are investing, so the importance of accounting conservatism and investment interest is increasing gradually. Based on big data, this paper explores the relationship between accounting conservatism and firm investment interest. The endings indicate that accounting conservatism has the following effects on investment profits. First, it can restrain excessive investment and second, it can aggravate underinvestment. If accounting conservatism restrains over-investment, the regression coefficient of accounting conservatism is −0.0265, and there is a remarkable change at the level of 4%. If this conservatism aggravates underinvestment, the regression coefficient of accounting conservatism and underinvestment is 0.0130, which is remarkable at the level of 0.9%.
We study intertemporal incentive properties of conditional accounting conservatism. Conservatism has detrimental and beneficial properties. In our first model, conservatism introduces downward bias in the first period; any understatement of first-period performance is reversed in the second period. A conservative bias is not costly in the first period but instead is costly in the second period when a new manager may be rewarded for the performance of his predecessor. In an extension on learning, we illustrate a beneficial role of conservatism in fine-tuning incentives. In the second model, conservatism is modeled as recognizing effort-independent bad news early and good news late. Recognizing bad news early can be optimal because of intertemporal rent shifting, which improves incentives via an “incentive spillback.” We also study overlapping projects (a multi-task setting) in which an interior accounting system can be optimal to avoid making one of the overlapping projects an incentive bottleneck.
JEL Classifications: D21; D74; D82; D86.
Conservatism is expected (1) to improve the monitoring process over managerial investment decisions, decreasing investment in settings where managers are likely to over-invest, and (2) to facilitate the access to external financing at lower cost, increasing investment in settings where managers are likely to under-invest. We find that more conservative firms are less likely to over- and under-invest. In addition, given that prior studies link excess monitoring to inefficient risk taking, we also analyze this potential downside of conservatism. We find a positive association between conservatism and future profitability, and no evidence that more conservative firms invest in less risky projects. The results are robust to controlling for the possible endogeneity between investment and conservative accounting choices, financial reporting quality, and governance provisions.
This paper analyzes the relation between equity prices and conditional conservatism and introduces a new measure of conservatism
at the firm-year level. We show that the asymmetric properties of conservative accounting, the existence of non-accounting
sources of information, and the properties of GAAP related to special items combine to generate a nonlinear relation between
unexpected equity returns and earnings news (the shock to expected current and future earnings). Based on this model, we construct
a conservatism ratio (CR) defined as the ratio of the current earnings shock to earnings news. CR measures the proportion
of the total shock to expected current and future earnings recognized in current year earnings. Ranking firms according to
CR, we show empirically that higher CR firms have more leverage, increased volatility of returns, more incidence of losses,
more negative accruals, and increased volatility of earnings and accruals, consistent with the literature on conservative
accounting.
KeywordsConservatism special items-Linearity-Return decomposition-Conservatism ratio
JEL ClassificationM41-G14
We study whether mandatory adoption of International Financial Reporting Standards (IFRS) is associated with changes in the sensitivity of CEO turnover to accounting earnings and how the impact of IFRS adoption varies with country‐level institutions and firm‐level incentives. We find that CEO turnover responds more to a firm's accounting performance after adoption. This increase in turnover‐to‐earnings sensitivity is concentrated in countries with stronger enforcement of financial reporting and is more prominent for mandatory adopters that have strong firm‐level compliance incentives. In addition, we link the change in turnover‐to‐earnings sensitivity directly to accounting changes due to IFRS adoption and find a stronger adoption effect when firms report large overall accounting changes and large de‐recognition of loss provisions upon adoption. Some of the above findings are sensitive to the exclusion of UK firms, which account for more than half of our sample.
We argue that a higher sensitivity to aggregate market-wide liquidity shocks (i.e., a higher liquidity risk) implies a tendency for a stock's price to converge to fundamentals. We test this intuition within the framework of the earnings-returns relationship. We find a positive liquidity risk effect on the relationship between return and expected change in earnings. This effect on the earnings-returns relationship is distinct from the negative effect observed for stock illiquidity level. Notably, the liquidity risk effect is evident (absent) during periods of neutral/low (high) aggregate market liquidity. We also show that the liquidity risk effect is dominant in firms that: (a) are of intermediate size; (b) are of intermediate book-to-market; and
A primary goal of both financial reporting research and audit research is to understand the determinants of quality, and researchers in both areas have identified a wide set of variables that enhance or impair quality. In this paper, we define financial reporting quality and audit quality and use a person/task/environment framework to summarize prior findings on the determinants of each. We use this framework to discuss the links between the financial reporting and audit academic literatures and highlight the recursive relation between financial reporting quality and audit quality. Our discussion provides insights and suggestions on how financial reporting and audit researchers can learn from each other to improve our collective understanding of financial reporting and audit quality. Using this framework, we also identify opportunities for future research.
This study examines the relation between performance covenants in private debt contracting and conservative accounting under adverse selection. We find that under severe adverse selection (i.e., high information asymmetry), accounting conservatism and performance covenants act as complements to signal that the borrower is unlikely to appropriate wealth from the lender. No such relation obtains in a low information asymmetry regime. We further show that in the high information asymmetry regime, borrowers with high levels of conservatism and tight performance covenants generally enjoy lower interest rate spreads than borrowers with low levels of conservatism and loose performance covenants. Consistent with our signaling theory, in the high information asymmetry regime, borrowers with high levels of conservatism and tight performance covenants are less likely to make abnormal payouts to shareholders. Our empirical results are robust to alternative measures of conservatism and covenant restrictiveness.This article is protected by copyright. All rights reserved.
This article examines the influence of majority shareholder ownership on real earnings management. It investigates whether there is a conflict between or an alignment of majority and minority shareholders' interests. If majority shareholders' interests are aligned with those of minority shareholders, a greater majority shareholder ownership lowers real earnings management. On the other hand, if they are not aligned, majority shareholders' attempts to exploit minority shareholders will increase real earnings management. This study does not find a systematic relationship between majority shareholder ownership and real earnings management. However, real earnings management significantly decreases in the upward earnings management incentive bracket as majority shareholder ownership increases. This occurs primarily because majority shareholders are more sensitive to upward real earnings management, which has a negative effect on future performance. These results suggest that the larger the ownership of majority shareholders, the more they play a positive role in mitigating real earnings management. This positive role is only effective in the post‐Asian economic crisis period. These results may suggest that the economic crisis in Korea helped majority shareholders more conscious of the long‐term costs of real earnings management. These findings support the convergence‐of‐interests hypothesis, providing evidence by investigating real earnings management instead of accruals‐based earnings management.
This study documents the relation between accounting conservatism and the differential response to operating accruals. Feltham and Ohlson's (1995) valuation framework predicts a positive association between the valuation multiple on operating assets and accounting conservatism. The relation between operating assets and operating accruals provides the basis for Feltham and Ohlson's (1995) further prediction of a positive association between the response coefficient to operating accruals and accounting conservatism. Stober (1996) and Ahmed, Morton, and Schaefer (2000) present evidence that the valuation multiple on operating assets is increasing in conservatism. Hence, by investigating the relation between conservatism and the differential response to operating accruals, this study extends the findings of Stober (1996) and Ahmed, Morton, and Schaefer (2000) and provides additional evidence on the agreement of the Feltham and Ohlson (1995) framework with the data.
Results are presented for both cross-sectional and firm-specific designs as well as alternative measures of conservatism. When firms are partitioned on conservatism, evidence is generally consistent with Feltham and Ohlson's (1995) prediction that as conservatism increases so does the magnitude of the response coefficient on operating accruals.
The concept of conditional conservatism (asymmetric earnings timeliness) has provided new insight into financial reporting and stimulated considerable research since Basu (1997). Patatoukas and Thomas (2011) report bias in firm-level cross-sectional asymmetry estimates that they attribute to scale effects. We do not agree with their advice that researchers should avoid conditional conservatism estimates and inferences from research based on such estimates. Our theoretical and empirical analyses suggest the explanation is a correlated omitted variables problem that can be addressed in a straightforward fashion, including fixed-effects regression. Correlation between the expected components of earnings and returns biases estimates of how earnings incorporate the information contained in returns. Further, the correlation varies with returns, biasing asymmetric timeliness estimates. When firm-specific effects are taken into account, estimates do not exhibit the bias, are statistically and economically significant, are consistent with priors, and behave as a predictable function of book-to-market, size, and leverage.
Data Availability: Data are publicly available from sources identified in the article.
This paper models the relation between a firm's market value and accounting data concerning operating and financial activities. Book value equals market value for financial activities, but they can differ for operating activities. Market value is assumed to equal the net present value of expected future dividends, and is shown, under clean surplus accounting , to also equal book value plus the net present value of expected future abnormal earnings (which equals accounting earnings minus an interest charge on opening book value).
A linear model specifies the dynamics of an information set that includes book value and abnormal earnings for operating activities. Model parameters represent persistence of abnormal earnings, growth , and accounting conservatism. The model is sufficiently simple to permit derivation of closed form expressions relating market value to accounting data and other information.
Three kinds of analyses develop from the model. The first set deals with value as it relates to anticipated realizations of accounting data. The second set examines in precise terms how value depends on contemporaneous realizations of accounting data. The third set examines asymptotic relations comparing market value to earnings and book values, and how earnings relate to beginning of period book values.
The paper demonstrates that in all three sets of analyses the conclusions hinge on the extent to which the accounting is conservative as opposed to unbiased. Further, the absence/presence of growth in operating activities is relevant if, and only if, the accounting is conservative.
Résumé. Les auteurs présentent sous forme de modèle la relation entre la valeur marchande d'une entreprise et les données comptables relatives à ses activités d'exploitation et ses activités financières. La valeur comptable est égale à la valeur marchande lorsqu'il s'agit d'activités financières, mais elle peut être différente dans le cas des activités d'exploitation. Les auteurs supposent que la valeur marchande est égale à la valeur actualisée nette des dividendes futurs prévus et démontrent que, lorsqu'on applique la méthode du résultat global , la valeur marchande est aussi égale à la valeur comptable additionnée de la valeur actualisée nette des bénéfices extraordinaires futurs prévus (qui sont égaux aux bénéfices comptables diminués de frais d'intérêt implicites sur la valeur comptable nette).
Un modèle linéaire précise la dynamique d'un ensemble de données, incluant la valeur comptable et les bénéfices extraordinaires, relatives aux activités d'exploitation. Les paramètres du modèle traduisent la persistance des bénéfices extraordinaires, la croissance et le principe de prudence. Le modèle est suffisamment simple pour permettre de dériver des expressions fermées qui mettent en relation la valeur marchande et les données comptables et autres.
Du modèle se dégagent trois formes d'analyses. La première porte sur la valeur, dans sa relation avec la matérialisation anticipée des données comptables. La deuxième porte sur l'examen précis du lien entre la valeur et la matérialisation actuelle des données comptables. Enfin, la troisième porte sur l'examen des relations asymptotiques à travers lesquelles se comparent la valeur marchande, d'une part, et les bénéfices et la valeur comptable, d'autre part, ainsi que sur la façon dont les bénéfices se rattachent aux valeurs comptables du début de l'exercice.
Les auteurs établissent que dans les trois formes d'analyses, les conclusions s'orientent vers la mesure dans laquelle, dans le domaine comptable, l'accent est mis sur la prudence par opposition à l'impartialité. En outre, l'absence ou la présence de croissance dans les activités d'exploitation n'est pertinente que si et seulement si le principe de prudence est appliqué à la comptabilité.
This study adds change in cash investments and change in lagged operating assets to the regression of returns on earnings levels and earnings changes examined in Easton and Harris (1991). We argue that a positive coefficient on change in cash investments captures conservatism associated with investments in positive net present value projects the effects of which will not flow into the accounting statements until the expected future benefits are realized. A positive coefficient on change in lagged operating assets implies accounting conservatism associated with the application of accounting rules to operating assets in place. Our empirical results are, in general, consistent with these arguments. We examine differences in conservatism across samples with different market to book ratios, we compare firms with non-negative returns with firms with negative returns, we compare firms reporting losses with firms reporting profits, and we examine firms in different industries, firms with different levels of research and development expenditure, different amounts of depreciation, different amounts of advertising expense, and firms that adopt LIFO inventory valuation compared with those that adopt an alternative to LIFO.
Recent studies have provided theory and evidence that the contemporaneous relation between stock returns and accounting earnings is nonlinear, different for profits and losses, and different across firms. Since each factor can result from differences in earnings persistence, existing theory is ambiguous as to whether these factors are distinct or overlapping. Thus, we conduct a simultaneous examination. Our primary tests show that each factor explains a significant portion of the variance of returns after controlling for the other two factors, with firm-specific estimation providing the largest incremental explanatory power. Alternative tests produce similar conclusions. Empirically, the three factors are distinct.
UK private and public companies face substantially equivalent regulation on auditing, accounting standards and taxes. We hypothesize that private company financial reporting nevertheless is of lower quality due to different market demand, regulation notwithstanding. A large UK sample supports this hypothesis. Quality is operationalized using Basu's (1997) time-series measure of timely loss recognition and a new accruals-based method. The result is not affected by controls for size, leverage, industry membership and auditor size, or by allowing endogenous listing choice. The result enhances understanding of private companies, which are predominant in the economy. It also provides insight into the economics of accounting standards.
We estimate a firm-year measure of accounting conservatism, examine its empirical properties as a metric, and illustrate applications by testing new hypotheses that shed further light on the nature and effects of conservatism. The results are consistent with the measure, C_Score, capturing variation in conservatism and also predicting asymmetric earnings timeliness at horizons of up to 3 years ahead. Cross-sectional hypothesis tests suggest firms with longer investment cycles, higher idiosyncratic uncertainty and higher information asymmetry have higher accounting conservatism. Event studies suggest increased conservatism is a response to increases in information asymmetry and idiosyncratic uncertainty.
ABSTRACT We quantify the relative importance of earnings announcements in providing new information to the share market, using the "R"-super-2 in a regression of securities' calendar-year returns on their four quarterly earnings-announcement "window" returns. The "R"-super-2, which averages approximately 5% to 9%, measures the proportion of total information incorporated in share prices annually that is associated with earnings announcements. We conclude that the average quarterly announcement is associated with approximately 1% to 2% of total annual information, thus providing a modest but not overwhelming amount of incremental information to the market. The results are consistent with the view that the primary economic role of reported earnings is not to provide timely new information to the share market. By inference, that role lies elsewhere, for example, in settling debt and compensation contracts and in disciplining prior information, including more timely managerial disclosures of information originating in the firm's accounting system. The relative informativeness of earnings announcements is a concave function of size. Increased information during earnings-announcement windows in recent years is due only in part to increased concurrent releases of management forecasts. There is no evidence of abnormal information arrival in the weeks surrounding earnings announcements. Substantial information is released in management forecasts and in analyst forecast revisions prior (but not subsequent) to earnings announcements. Copyright (c), University of Chicago on behalf of the Institute of Professional Accounting, 2008.
Conservatism is interpreted to mean that accountants more frequently report current "bad news" about future cash flows in contemporaneous earnings than current "good news." Thus, earnings reported under GAAP should be more timely in reporting "bad news" about future cash flows than "good news." This paper, using the firm's stock return as a measure of news, shows that the contemporaneous association between earnings and negative returns is two to five times as large as the contemporaneous association between earnings and positive returns. It is also shown that the greater timeliness of earnings relative to cash flow measures is largely due to a greater sensitivity to concurrent negative returns. This result is consistent with accountants recording accruals conservatively. Another implication of conservatism is that negative earnings surprises are likely to be less persistent than positive earnings surprises, because earnings reports more bad news concurrently than good news, with the latter being spread over several periods. This is shown to be true empirically. It is predicted and found that earnings response coefficients are higher for positive earnings changes than for negative earnings changes, which is consistent with the market correcting for the difference in persistence in conservatively determined earnings. It is also found that the sensitivity of earnings to negative returns has more than quadrupled since 1980, while the sensitivity of earnings to negative returns has declined by two-thirds, suggesting that earnings measurement has become more conservative. Increases in accounting conservatism are found to be correlated with increases in auditor liability, but no causal inferences are drawn.
Measuring reporting conservatism
- D Givoly
- C Hayn
- A Nataragan
Givoly, D., Hayn, C. & Nataragan, A. (2007) "Measuring reporting conservatism",
The Accounting Review, vol. 82: 65-107
Ex-ante and ex-post accounting conservatism, asset recognition and asymmetric earnings timeliness
- P F Pope
- M Walker
Pope, P. F. & Walker, M. (2003) "Ex-ante and ex-post accounting conservatism,
asset recognition and asymmetric earnings timeliness", working paper,
Lancaster University and The University of Manchester.