Asymmetric Timeliness Of Earnings Research Articles

Estimation and Empirical Properties of a Firm-Year Measure of Accounting Conservatism

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 three 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.

Accounting conservatism of cross-listing firms in the pre- and post-Sarbanes Oxley periods

Abstract This study investigates the level of accounting conservatism of a sample of cross-listed firms, American Depository Receipts (ADRs), during the pre- and post-Sarbanes Oxley (SOX) periods. After examining two proxies for accounting conservatism, Basu's [Basu, S. (1997). The conservatism principle and the asymmetric timeliness of earnings. Journal of Accounting and Economics 24(1), 3–37.] conservatism measure and abnormal accruals, we find that the SOX-exposed Levels II and III ADRs become more conservative during the post-SOX period while the SOX-unexposed Level I ADRs have no increase in the level of accounting conservatism. Further, we investigate whether such an increase in accounting conservatism is associated with different levels of shareholder protection in ADRs' home countries, and find that only Levels II and III ADRs from code law (weak shareholder protection) countries become more conservative and Levels II and III ADRs from common law (strong shareholder protection) countries have no change in accounting conservatism. These results suggest that SOX-exposed cross-listing firms from weak shareholder protection countries are most greatly influenced by the stringent requirements in SOX, and hence respond by increasing conservatism in their financial reporting.

Adjusting Linear Information Models for the Asymmetric Timeliness of Earnings*

We provide evidence that conditional conservatism could be better captured in linear information models (LIMs), which largely rely on analysts' forecasts, if analysts would adjust their optimistic forecast for the asymmetric timeliness of earnings. Since adjusting the forecast requires information of the next period the adjusted model could be regarded as a benchmark to investigate conditional conservatism in LIMs. We demonstrate that for a joint parameter estimation of the Choi/O'Hanlon/Pope (2006) model based on adjusted forecasts valuation errors are reduced. For a market-to-book specific implementation the adjusted model improves valuation errors for the 30% highest conservative firms. Moreover, the adjustment reduces the asymmetric timeliness in the valuation error indicating that the adjusted model helps capturing conditional conservatism. Our results imply that LIMs will benefit from an adjustment for conditional conservatism particularly in the case of a joint parameter estimation and when concern is with high conservative firms.

How Timely are Earnings When Costs are Sticky? Implications for the Link Between Conditional Conservatism and Cost Stickiness

We interpret cost stickiness, i.e., the manager's decision to bear the costs of unutilized resources when sales decline, as a risky project and examine its impact on conditional conservatism. We find that cost stickiness increases the asymmetric timeliness of earnings by weakening the timeliness of earnings for good news firms and, at the same time, intensifying the timeliness of earnings for bad news firms. Additionally, the results suggest that the asymmetric timeliness of earnings for cost sticky firms is more strongly driven through accounting factors, as reflected in accruals than through non-accounting factors, as reflected in cash flow. Our results imply that cost stickiness is more costly due to conditional conservatism and that the market separates the efficient from the inefficient cost sticky firms indicating that information asymmetry is low. Future research could test whether conditional conservatism helps mitigating the information asymmetry induced by cost stickiness.

Managerial Ownership and Accounting Conservatism

ABSTRACTIn this paper we examine the effect of managerial ownership on financial reporting conservatism. Separation of ownership and control gives rise to agency problems between managers and shareholders. Financial reporting conservatism is one potential mechanism to address these agency problems. We hypothesize that, as managerial ownership declines, the severity of agency problem increases, increasing the demand for conservatism. Consistent with our hypothesis, we find that conservatism as measured by the asymmetric timeliness of earnings declines with managerial ownership. The negative association between managerial ownership and asymmetric timeliness of earnings is robust to various controls, in particular, for the investment opportunity set. We thus provide evidence of a demand for conservatism from the firm's shareholders.

Reassessing the Role of Book-Tax Conformity

Book-tax conformity refers to the legal link between financial and tax accounts, and is an institutional feature of many continental European countries and countries like Japan that follow continental European traditions. Many studies argue that book-tax conformity impedes earnings informativeness. However, book-tax-conformity is required for single accounts but not for group accounts, which are used to inform capital markets. Previous research has not properly used this distinction. The absence of a formal link between group income and taxable income makes a causal empirical relationship between legal book-tax conformity and resulting cross-country differences in group earnings properties much less compelling. We argue that studies documenting this relationship suffer either from an omitted variable problem (i.e., failure to sufficiently control for differences in reporting incentives) or sample selection bias (inclusion/noninclusion of single accounts in the test sample). We reassess cross-country differences in asymmetric earnings timeliness and find that legal book-tax conformity does not affect cross-country differences in group earnings properties when the institutional environment is adequately controlled for. Instead, group accounting follows typical reporting incentives even in countries where there is high book-tax conformity for single accounts. Furthermore, we show that even tax-dominated single accounts are responsive to nontax reporting incentives.

Discussion of “Asymmetric timeliness of earnings, market-to-book and conservatism in financial reporting”

Roychowdhury and Watts [2007. Asymmetric timeliness of earnings, market-to-book and conservatism in financial reporting. Journal of Accounting and Economics.] provide a thought-provoking discussion of an important topic and consider a controversial role of accounting inconsistent with the valuation perspective of accounting currently adopted by standard setters. The paper uses a contracts-based view of accounting to explain the empirical relation between two measures of conservatism, the market-to-book ratio and asymmetric timeliness. Although the predictions from their framework are consistent with the previously documented negative correlation between these measures, suggesting this criticism of asymmetric timeliness may be misguided, I will be surprised if their paper eliminates the controversy over these measures of conservatism.

Asymmetric timeliness of earnings, market-to-book and conservatism in financial reporting

Using an accounting conservatism theory that reflects accounting's role in practice, we investigate the relation between two extensively used measures of conservatism: asymmetric timeliness of earnings and the market-to-book ratio (MTB). We predict and observe that when asymmetric timeliness is measured cumulatively over long periods, its relation with end-of-period MTB is positive. When asymmetric timeliness is measured over short periods, its dependence on beginning-of-period composition of equity value (EV) is responsible for its negative association with MTB. Further, asymmetric timeliness appears to measure conservatism more efficiently when it is estimated cumulatively over multiple periods.

International Differences in Conditional Conservatism – The Role of Unconditional Conservatism and Income Smoothing

Prior research documents that conditional conservatism, measured as the asymmetric timeliness of earnings reflecting bad vs. good news, varies with cross-country differences in institutional regimes. In this paper, we examine the determinants of conditional conservatism and related earnings attributes internationally. First, using panel data, we investigate whether competing earnings attributes such as unconditional conservatism and income smoothing affect conditional conservatism and its international differences. We find that these attributes are predictably correlated with conditional conservatism. Second, we address the question whether income smoothing and conditional conservatism are two fundamentally different earnings attributes. We show theoretically that both attributes yield different earnings distributions and that the motivations for producing earnings which possess these attributes differ. To test these predictions empirically, we calculate firm-specific time-series measures of asymmetric timeliness, using a novel trigonometric measure based on the standard Basu (1997)-type regression. Using this cross-sectional data, we test whether conditional conservatism and income smoothing are different and find them to be only weakly correlated for a broad international sample. Also, we demonstrate that income smoothing explains international differences in conditional conservatism. Finally, we estimate simple determinant models of conditional conservatism and income smoothing, showing that both earnings attributes are driven by different explanatory firm-level factors: Conditional conservatism increases with the importance of debt financing, while income smoothing increases with the importance of dividends. Despite some important limitations, we believe our results to be meaningful because they show that cross-country differences in conditional conservatism are influenced by the effects of other accounting properties, predominantly income smoothing. Especially, legal regime appears to drive income smoothing while losing its explanatory power for conditional conservatism when firm-specific factors are controlled for.

Managerial Ownership and Accounting Conservatism

In this paper we examine the effect of managerial ownership on financial reporting conservatism. Separation of ownership and control gives rise to agency problems between managers and shareholders. Financial reporting conservatism is one potential mechanism to address these agency problems. We hypothesize that as managerial ownership declines, the severity of agency problem increases, increasing the demand for conservatism. Consistent with our hypothesis, we find that conservatism as measured by the asymmetric timeliness of earnings declines with managerial ownership. The negative association between managerial ownership and asymmetric timeliness of earnings is robust to various controls for the investment opportunity set. We thus provide evidence of a demand for conservatism from the firm's shareholders.

Earnings conservatism: panel data evidence from the European Union and the United States

This paper focuses on earnings conservatism, and provides new evidence based on procedures that account for variability at the firm level, drawing a comparison between the European Union and the United States. A key finding is that the estimated responsiveness of earnings to bad news is substantially higher when unobserved firm‐specific effects are modelled. Furthermore, it is shown that accounting has become more conservative not only in the U.S. but also in the EU when taken as a whole, and there is little evidence of marked differences in the asymmetric timeliness of earnings between the two. Indeed, any changes in this property of earnings are likely to be attributable to a common factor that influences firms similarly in both locations, and not necessarily to the process of economic convergence that has taken place in the EU.

Asymmetric Timeliness of Earnings, Market-to-Book and Conservatism in Financial Reporting

When annual earnings are regressed on annual returns, the returns coefficient is higher when returns are negative. The difference between the coefficients of earnings on positive and negative returns is called asymmetric timeliness of earnings and, in the accounting literature, is used extensively as a conservatism measure. The objective of this paper is to investigate the relation between asymmetric timeliness and the market-to-book ratio (MTB), using a theory of accounting conservatism that reflects the role of accounting as observed in practice. Recent literature has focused on the negative relation between the two measures. Using our theory of conservatism, we predict and observe empirically that the relation between asymmetric timeliness over a period and MTB at the end of the period is positive when asymmetric timeliness is measured cumulatively over long horizons. Our paper further highlights that when asymmetric timeliness is measured over short periods not including the firm's IPO, it is dependent on the composition of equity value at the beginning of that period. This dependence is responsible for the negative association observed between asymmetric timeliness estimated over short periods and MTB at the end of the period. Our theory and empirical results further suggest that asymmetric timeliness is a better measure of total conservatism at a point in time when it is estimated cumulatively over multiple years preceding that time. Overall, our results are consistent with our theory that accounting does not record changes in rents and is asymmetrically timely in recording changes in separable asset values.

Conditional and Unconditional Conservatism:Concepts and Modeling

We develop a model that captures the distinct natures of and interactions between conditional and unconditional conservatism. Under unconditional conservatism, the book value of net assets is understated due to predetermined aspects of the accounting process. Under conditional conservatism, book value is written down under sufficiently adverse circumstances, but not up under favorable circumstances. The specification of earnings provided by the model yields hypotheses about how unconditional conservatism and other factors preempt conditional conservatism and so affect the asymmetric response of earnings to positive and negative share returns, both current and lagged, documented by Basu (1995, “Conservatism and the Asymmetric Timeliness of Earnings.” Ph.D. dissertation, University of Rochester’ 1997, “The Conservatism Principle and the Asymmetric Timeliness of Earnings.” Journal of Accounting and Economics 24, 3–37).

International Differences in Conditional Conservatism: The Role of Unconditional Conservatism and Income Smoothing

Prior research documents that conditional conservatism, measured as the asymmetric timeliness of earnings reflecting bad versus good news, varies with cross-country differences in institutional regimes. In this paper, we examine the determinants of conditional conservatism and related earnings attributes internationally. First, using panel data, we investigate whether competing earnings attributes such as unconditional conservatism and income smoothing affect conditional conservatism and its international differences. We find that these attributes are predictably correlated with conditional conservatism. Second, we address the question whether income smoothing and conditional conservatism are two fundamentally different earnings attributes. We show theoretically that both attributes yield different earnings distributions and that the motivations for producing earnings which possess these attributes differ. To test these predictions empirically, we calculate firm-specific time-series measures of asymmetric timeliness, using a novel trigonometric measure based on the standard Basu (1997)-type regression. Using this cross-sectional data, we test whether conditional conservatism and income smoothing are different and find them to be only weakly correlated for a broad international sample. Also, we demonstrate that income smoothing explains international differences in conditional conservatism. Finally, we estimate simple determinant models of conditional conservatism and income smoothing, showing that both earnings attributes are driven by different explanatory firm-level factors: conditional conservatism increases with the importance of debt financing, while income smoothing increases with the importance of dividends. Despite some important limitations, we believe our results to be meaningful because they show that cross-country differences in conditional conservatism are influenced by the effects of other accounting properties, predominantly income smoothing. Especially, legal regime appears to drive income smoothing while losing its explanatory power for conditional conservatism when firm-specific factors are controlled for.

The Association between Big 6 Auditor Industry Expertise and the Asymmetric Timeliness of Earnings

The accounting profession is facing a credibility crisis precipitated by the failure of several high-profile companies and the alleged failure of their auditors to detect and persuade their clients to recognize economic losses in earnings in a timely fashion. Investors, regulators, analysts, and the public are interested in identifying factors that enhance the timeliness of earnings, particularly about bad news. This study provides empirical evidence on one such factor—auditors' industry expertise. Using a large sample of clients of Big 6 auditors, this research examines the association between auditor industry expertise, measured in terms of an industry's share in the auditor's portfolio of client industries, and the speed with which publicly available bad news about future cash flows is recognized in earnings. The findings indicate that the earnings of clients of specialist auditors are more timely in reflecting bad news than earnings of clients of nonspecialist auditors. This finding is consistent with the notion that auditors' industry expertise moderates the tendency of auditees to delay the recognition of economic losses in earnings.

The Effect of Earnings Management on the Asymmetric Timeliness of Earnings

Abstract: Is earnings management affecting (driving) the measures of earnings conservatism?Ball et al. (2000) point out that the asymmetry in the recognition of good and bad news in earnings (faster recognition of bad news: earnings conservatism) is more pronounced in common‐law than in code‐law based accounting regimes. However, comparative studies on earnings conservatism in Europe have failed to identify significant differences between common‐law and code‐law based countries. We argue that in code‐law based countries managers have incentives to reduce earnings consistently. This enhances the association between earnings and returns in bad news periods. We find that after controlling for discretionary accruals, the differential earnings response to bad news in Germany and France decreases significantly.

Discussion of The Effect of Earnings Management on the Asymmetric Timeliness of Earnings

Journal of Business Finance & AccountingVolume 32, Issue 3-4 p. 727-736 Discussion of The Effect of Earnings Management on the Asymmetric Timeliness of Earnings Stuart J. McLeay, Corresponding Author Stuart J. McLeay The author is from the University of Wales. Stuart J. McLeay, University of Wales, Bangor, Wales, UK. e-mail: [email protected]Search for more papers by this author Stuart J. McLeay, Corresponding Author Stuart J. McLeay The author is from the University of Wales. Stuart J. McLeay, University of Wales, Bangor, Wales, UK. e-mail: [email protected]Search for more papers by this author First published: 20 April 2005 https://doi.org/10.1111/j.0306-686X.2005.00611.xCitations: 4 Read the full textAboutPDF ToolsRequest permissionExport citationAdd to favoritesTrack citation ShareShare Give accessShare full text accessShare full-text accessPlease review our Terms and Conditions of Use and check box below to share full-text version of article.I have read and accept the Wiley Online Library Terms and Conditions of UseShareable LinkUse the link below to share a full-text version of this article with your friends and colleagues. Learn more.Copy URL Citing Literature Volume32, Issue3-4April 2005Pages 727-736 RelatedInformation

The Conservatism Principle and the Asymmetric Timeliness of Earnings: An Event-Based Approach

In this paper, we test the conservatism and asymmetric timeliness hypothesis by using information in extreme events as a measure of good/bad news. The methodology we develop provides a more powerful test of asymmetric timeliness by focusing on major events that occur in short event windows and whose accounting is likely to receive special attention from managers. Our approach has several other advantages over that used by prior studies: (i) we provide complete evidence on conservatism by testing both implications of asymmetric timeliness: higher correlation of bad news with concurrent earnings as tested by prior studies and delayed earnings recognition of good news; (ii) our event-based research design is not subject to inferential concerns that may apply to some prior research; and (iii) our analysis based on components of earnings provides a stronger test of asymmetric timeliness by eliminating the effect of differential persistence of good news versus bad news. Our evidence is consistent with the conservatism and asymmetric timeliness hypothesis.