The Impact of Accounting Conservatism on the Magnitude of the Differential Information Content of Cash Flows and Accruals

Abstract

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.