Income Conservatism in the U.S. Technology Sector

Abstract

We investigate the extent and nature of income conservatism as reflected in the financial statement numbers of firms in the U.S. technology sector. Technology firms are predicted to have greater income conservatism than other U.S. firms because they are subject to both higher shareholder litigation risk and conservative accounting standards such as SFAS 2. In the absence of a generally accepted measure of conservatism, we examine several proxies including loss incidence and accounting rates of return, operating cash flow and non-operating accrual levels, and regression coefficients from the income timeliness models in Basu (1997). Relative to other companies, technology firms are characterized by higher (and intertemporally increasing) levels of income conservatism. These differences are both statistically and economically significant. Further analysis suggests that technology firms' higher conservatism results primarily from conservative accounting rules for R&D expensing rather than shareholder litigation risk.