Conditional Conservatism Research Articles

Estimating a firm-year measure of conditional conservatism for non-U.S. firms: evidence from Japan

ABSTRACT C_Score, a firm-year-level conditional conservatism measure, is widely used in international accounting research because of its parsimony, that is, the use of firm size, market-to-book ratio, and leverage as the main variables. However, it is developed for the U.S. and may not be valid in other countries because their institutional features differ from the U.S. We replicate the property tests of Khan and Watts (2009, ‘Estimation and empirical properties of a firm-year measure of conditional conservatism,’ Journal of Accounting and Economics 48: 132–150) and further investigate its validity using data from Japanese listed firms. Our findings are summarized as follows: first, market-to-book ratio and leverage are not statistically significant for many years. Second, C_Score does not predict future asymmetric timeliness of earnings. Third, the three variables’ contributions to C_Score’s variance fluctuate over time. Fourth, our result shows that firm size solely determines the measure for many years. Fifth, cash flow asymmetry, not accrual asymmetry, affects the asymmetric timeliness of earnings across the deciles based on C_Score. Finally, we find no relationship between C_Score and asset write-downs including non-current asset impairments. Overall, our findings suggest that C_Score is not valid for Japanese listed firms.

Direct and indirect effects of unconditional conservatism on investment efficiency

PurposeThis study aims to investigate the effects of unconditional conservatism on investment efficiency, focusing on both its direct and indirect effects.Design/methodology/approachWe conduct multiple regression analyses on a sample of nonfinancial companies listed on the New York Stock Exchange from 2010 to 2018.FindingsWe provide evidence that conditional conservatism plays a central role in mediating the indirect effects of unconditional conservatism on investment efficiency. This is because a decrease in conditional conservatism, following an increase in unconditional conservatism, leads to reduced investment efficiency.Research limitations/implicationsThis study offers valuable insights for the growing body of literature on the relationship between accounting conservatism and investment efficiency while emphasizing the critical role of conditional conservatism in mediating the relationship between unconditional conservatism and investment efficiency.Practical implicationsThis study has several implications. Practitioners can make informed decisions regarding accounting policies, predict the potential effects of these choices and mitigate the negative impact of unconditional conservatism on investment efficiency. Investors can make more informed decisions by understanding how unconditional and conditional conservatism affect investment efficiency. Standard setters can guide user behavior toward more efficient investment decisions.Originality/valueConsidering the lack of comprehensive understanding in prior literature regarding the underlying mechanisms through which unconditional conservatism influences investment efficiency, this study investigates the direct and indirect effects characterizing this relationship. We provide evidence supporting a new explanation for the relationship between unconditional conservatism and investment efficiency.

Monitoring by a single banker and accounting conservatism: evidence from India

PurposeThis paper aims to investigate the effect of bank monitoring on conditional conservative accounting of Indian listed firms. Drawing on bank monitoring and relationship lending literature, the study hypothesizes that monitoring by a single bank reduces the bank’s demand for conservatism-facilitated control transfers.Design/methodology/approachThe empirical design is composed of three steps. In the first step, using data on Indian firms listed in NSE and BSE for the period 2000–2019, market-based firm-year measure and accrual cash flow-based firm-year measure of conditional conservatism is estimated. In the second step, we test the hypothesis using multivariate panel regression corrected for heteroskedasticity and incorporating firm and year-fixed effects. In the third step, we test for the robustness of the results using Heckman’s correction approach.FindingsResults indicate that firms which are monitored by a single bank tend to be less conservative. Also, the negative association between single bank monitoring and conservatism is stronger when the firm’s debt structure is dominated by bank debt.Research limitations/implicationsThe study’s scope does not include analyzing the influence of characteristics of the single banker monitoring the firm. Future research could investigate attributes like ownership of the banker as a possible source of variation in the relationship documented in this study.Practical implicationsAccounting standard-setting boards are now discouraging implementation of conservatism to avoid bias in financial reporting. This paper finds that a strong bank–firm relationship can be a possible substitute for conservatism.Originality/valueThe study sheds new light on the debt structure–conservatism relationship. Bank’s availability of inside information through the transaction account and its impact on lending relationships is established in the literature. However, the literature on the determinants of conservatism has not examined how the benefit enjoyed by the firm’s single banker, possessing all the information in the transaction account can lead to bank’s reduced dependence on financial statements and subsequently reduced accounting conservatism of borrowing firms.

Does climate risk shape firms’ accounting conservatism?

We study how climate risk shapes accounting conservatism with data collected from 47 countries. The results suggest that firms that are exposed to higher climate risk use more conditional conservatism, but less unconditional conservatism in their financial reporting. Furthermore, the effect of climate risk on both unconditional conservatism and conditional conservatism is significantly strengthened, both statistically and economically, in well-governed countries. We also find that in countries with higher uncertainty avoidance, the effect of climate risk on unconditional conservatism is significantly enhanced but the effect on conditional conservatism is significantly weakened. Our findings, which are robustly supported by a number of sensitivity checks, enrich the emerging literature on the socio-economic impact of climate risk.

Accruals and Long-Term Nonfinancial Assets and Liabilities

ABSTRACT This study proposes improvements to accrual models. Existing models explain how working capital maps cash flows from operations into earnings and how this mapping reflects accounting conservatism. However, except for fixed asset depreciation, accruals associated with long-term nonfinancial balance sheet accounts (e.g., intangible assets, goodwill, deferred revenues) are not modeled. We show that these unmodeled accruals have grown in importance over time and that a significant portion of them can be explained by utilizing a fundamental property of accrual accounting: most nonfinancial assets and liabilities will eventually be transferred to earnings as accruals, especially during bad times. Using a large U.S. sample for the 1988–2019 period, we document that beginning-of-year long-term nonfinancial assets and liabilities are significantly associated with total accruals and that, consistent with conditional conservatism, a greater proportion of long-term nonfinancial assets is expensed as accruals when current performance is poor. In simulations, compared to traditional models, models that include long-term nonfinancial assets and liabilities as regressors are more likely to detect seeded discretionary accruals between 2% and 20% of total assets, suggesting that these expanded models should be used to decrease the likelihood of making erroneous inferences.

CEO Optimism, Accounting Conservatism and Earnings Management of ListedManufacturing Firms: Evidence from Asian Emerging Economies

It is pertinent to understand how CEO optimism and accounting conservatisminfluence earnings management to verify the reliability and accuracy of financial reporting. The motivation behind this research comes from the possible implications for financial transparency, regulatory oversight, and investor trust while focusing on the usefulness of corporate governance. The research explores the influence of CEO optimism and accounting conservatism on earnings management within Asian emerging economies, analyzing data fromlisted manufacturing firms between 2010 and 2022. The study finds a negative correlation between accounting conservatism and earnings management while CEO optimism positively correlates with earnings management. These findings imply that conditional conservatism diminishes the possibility for management to inflate earnings. However, CEO optimism increases the likelihood of a firm's earnings management. This research ought to offer a thorough understanding of accounting conservatism and CEO optimism and the effect that these factors have on earnings management from the context of Asian emerging economies.

Tension in Financial Reporting: Reacting to a Peer Bankruptcy Announcement

We investigate if and how a peer’s bankruptcy affects financial reporting by other firms within the industry. Prior research documents that the bankruptcy filing of a peer firm has negative capital market effects on other firms within the industry (lower stock market value and higher cost of debt). We argue that firms within an industry experiencing peer bankruptcies modify their financial reporting to mitigate such negative capital market effects. However, tension arises as to whether such modification is toward more conservative accounting or the opposite. Using a large sample of firms from 1980 to 2018, we find that following a peer firm bankruptcy filing, other firms within the industry exhibit a rise in conditional conservatism in their financial reporting. Our findings are robust to a battery of tests including the exclusion of distressed industries, the 2000 dot-com crash period, and the 2008 financial crisis period as well as employing an alternative proxy for conditional conservatism. The results are not significant for placebo bankruptcies 1 and 2 years before actual bankruptcies. Further analyses show that the spillover effects are more pronounced for firms in homogeneous industries, which exhibit higher leverage, with strong governance mechanisms, and in industries that experience strong market reaction following peer bankruptcy announcements. We also find that the bankruptcy filing of larger and older firms leads to stronger spillover effects.

Does liquidity connectedness affect stock price crash risk? Evidence from China

Using a sample of CSI300 over the 2006–2021 period to establish liquidity spillover networks, we find a significantly negative relationship between liquidity connectedness and stock price crash risk. Further analysis shows that liquidity connectedness depresses stock price crash risk through two potential channels: increased conditional conservatism and decreased stock price synchronicity. Moreover, this effect is more prominent for firms with effective external monitoring, firms with lower risk-taking, and state-owned enterprises (SOEs). Overall, our paper shows that liquidity connectedness is an important factor influencing crash risk and provides useful guidance for corporate management and investor decision-making.

Does asymmetric cost behaviour impact conditional conservatism practices? A quantile regression approach

Does asymmetric cost behaviour impact conditional conservatism practices? A quantile regression approach

The Effect of the Current Expected Credit Loss Model on Conditional Conservatism of Banks and Its Spillover Effect on Borrower Conservatism

The Effect of the Current Expected Credit Loss Model on Conditional Conservatism of Banks and Its Spillover Effect on Borrower Conservatism

Business strategy, earnings properties, and earnings quality

This study explores the relationship between business strategy and earnings properties, which are frequently considered as proxies of earnings quality. Specifically, we examine the implications of different strategic positionings for earnings properties that are related to earnings management, conditional conservatism, earnings persistence, and earnings smoothness. Using an international sample, our empirical results indicate that business strategy is inherently linked to these earnings properties. Firms that focus on a business strategy of continuous innovation have larger discretionary accruals, more persistent earnings, and lower earnings smoothness relative to firms that focus on a business strategy of operation efficiency. We also find some evidence for differences in conditional conservatism, although the associations are weaker and sensitive to sample composition. Our main inference is that business strategy inherently affects earnings properties.

IPO conditional conservatism, underpricing and post-issue stock market survival

PurposeWe examine the association between conditional conservatism in initial public offering (IPO) underpricing and post-issue stock market survival in the U.S.Design/methodology/approachWe adopt an archival approach by collecting data for 1,761 U.S. IPO issuers for the period 1990–2017. Regression analyses are conducted to evaluate the association between conditional conservatism in initial public offerings with underpricing and post-issue stock market survival. We identify firms that went public in the period 1990–2012. These firms are then followed for five years after the IPO to assess their stock market survival.FindingsWe find that pre-issue conditional conservatism is significantly associated with less IPO underpricing. We also detect that IPO firms with higher levels of conditional conservative reporting are more likely to survive in the post-IPO stock market in the three-, four-, and five-year periods after the IPO. Our main findings are robust after controlling for other factors in our models, such as IPO cycles, venture capitalists, research and development investment, and pre-IPO accounting performance.Originality/valueWe extend research by demonstrating that conditional conservative reporting practices help firms reduce their indirect costs of raising their initial public capital. Additionally, our research introduces new evidence on the association between pre-IPO conditional conservatism and after-issue stock market survival. Our findings empirically support the International Accounting Standards Board’s (IASB) decision to reintroduce the concept of prudence into the conceptual framework, by showing how conservative reporting can reduce information asymmetry in IPO firms.

Firm Type and Unconditional Conservatism: The Indian Experience with IFRS Convergence

This paper investigates how private and public firms vary with respect to unconditional conservatism in financial reporting in the pre and post IFRS worlds. I consider unconditional conservatism (UC) which pre-empts the more commonly studied conditional conservatism, private firms that are differently regulated, IFRS convergence instead of the more uniform IFRS adoption and an emerging market. Using a large Indian sample of 63,000 observations across more than 15,500 firms (~41% are private) over 10 years (2011-2020), I show that private firms are less unconditionally conservative than public firms. Also, contrary to literature, IFRS convergence increases conservatism in India and reduces the conservatism gap between private and public firms. These results hold even after controlling for monitoring, governance, and group-affiliation. This adds significantly to our understanding of how the effect of uniform accounting standards on reporting choices of different firm types varies significantly by and within a context and region.

Share pledging by controlling shareholders and accounting conservatism: evidence from India

PurposeThe purpose of this paper is to examine the relationship between accounting conservatism and pledging of shares by controlling shareholders of a firm to obtain a loan. The pledging of shares by the controlling shareholders of a firm results in alterations to the payoff and risk structure for these shareholders. Since accounting numbers have valuation implications, pledging of shares by a controlling shareholder has an impact on accounting policy choices made by the firm. The purpose of this paper is to examine the impact of controlling shareholder share pledging to obtain a loan on a specific accounting policy choice, namely, conservatism.Design/methodology/approachThe paper uses a large data set from India comprising 14,786 firm years consisting of 1,570 firms belonging to 58 industries for a period of 11 years (2009–2019). The authors use ordinary least square regression with robust standard errors. The authors conduct robustness checks and the results are consistent across alternative statistical methodologies and alternative measures of the primary dependent and independent variables.FindingsThe primary results show that pledging of shares by the controlling shareholders results in higher conditional conservatism and lower unconditional conservatism. Further analysis reveals that the relationship is stronger when the controlling shareholder holds a majority ownership in the firm. Additionally, the results show that for business group affiliated firms, which are unique to developing countries, both the conditional and the unconditional conservatism are incrementally lower when the controlling shareholder pledges the shares. For family firms with a family member as CEO, the conditional conservatism is incrementally higher and the unconditional conservatism is incrementally lower. Finally, the authors show that the results hold when the pledge intensity variable is measured with a one-year lag and finally, the authors show that conditional conservatism is incrementally higher in the year of the increase in the pledge and the year after, but there is no such incremental impact on unconditional conservatism.Research limitations/implicationsThe research is limited to the listed firms in India. Since majority of the listed firms are controlled by families and the family firms around the world are heterogeneous the findings of the research may not be applicable to other countries.Practical implicationsThe study has implications for policy-making and monitoring of the pledging by the controlling shareholders. It also helps the investors in making investment decisions with respect to family firms in India.Originality/valueThe study is unique as it focuses on the relationship between pledging of shares by the controlling shareholders and its impact on accounting conservatism. To the best of the authors’ knowledge, this is the first research integrating these two aspects.

Shaping Firms’ Financial Reporting: Evidence From the Spillover Effect of the FED’s Stress Test

This research investigates how bank regulation, specifically the stress test conducted by the Federal Reserve (FED), influences the financial reporting decisions of borrowers. Previous studies indicate that the FED’s stress test can lead to a reduction in credit supply and stricter lending standards for banks. Expanding on this body of literature, our study shows that the impact of the stress test reaches beyond lenders, prompting borrowers to embrace increased conditional conservatism in their financial reporting. This spillover effect is particularly pronounced for riskier borrowers. Our findings suggest a far-reaching impact of FED regulation on firms’ financial reporting choices. Further analysis indicates that borrowers transitioning from tested banks to untested banks experience higher interest rates following the stress test, highlighting an extended spillover effect on borrowers.

Costos de agencia y conservadurismo condicional de empresas públicas en la industria eléctrica brasileña

Introduction / objective: In organisations, conflicts of interest give rise to agency costs aimed at mitigating agent opportunism. High-quality accounting information reduces these conflicts by minimising information asymmetry. Consequently, this study aims to investigate the relationship between agency costs and conditional conservatism in Brazilian electric power industry companies listed on the B3. Methodology: Data from 21 Brazilian electric power industry companies for the period 2012 to 2020 were utilised. Twenty-four attributes associated with agency costs were analysed, and Ball and Shivakumar’s (2005) conditional conservatism model was employed as a measure of accounting information quality. Panel data regression models were used to obtain the results. Results: According to the central conditional conservatism model, companies tend to exhibit optimism rather than conservatism, anticipating gains instead of losses. Results, assessed across five dimensions, revealed that factors such as board composition, variable compensation, and agreements with shareholders reduce optimism, while qualified audits, longer tenures, and the presence of a permanent audit committee increase optimism. Therefore, attributes that influence optimism, accounting information neutrality, and consequently, financial reporting quality, are identified. Conclusions: This study benefits various users of accounting information. Investors can pinpoint governance policies that align interests, regulators can enhance oversight, and organisation members can adopt policies that encourage the alignment of interests between principals and agents.

Manager sentiment and conditional conservatism

AbstractThis study examines the effect of manager sentiment on conditional conservatism. Manager sentiment refers to widely held beliefs of financial managers about their firms’ future economic prospects that are not justified by available economic fundamentals. Manager sentiment is likely to affect conditional conservative reporting because the decision to recognize unrealized economic losses in a timely manner flows from financial managers’ beliefs about their firms’ future cash flow prospects. We predict and find that manager sentiment is negatively associated with conditional conservatism, indicating that firms report less conservatively during periods of high manager sentiment (over‐optimism) and more conservatively during periods of low manager sentiment (over‐pessimism). Moreover, the effects of manager sentiment on conditional conservatism remain strongly negative after controlling for manager overconfidence. We further find that asset write‐offs are lower during high sentiment periods but higher in subsequent periods. Importantly, the manager sentiment effect on conservatism is incremental, and the opposite in sign, to the effect of investor sentiment, which has not been demonstrated in prior literature.

Leader-following consensus control for nonlinear multiagent systems with unknown time-varying measurement sensitivity and infinite communication delays

This paper investigates the consensus problem for nonlinear multiagent systems (MASs) with unknown time-varying measurement sensitivity and infinite communication delays. Unlike existing works, the output measurement sensitivity is described as time-varying, and an infinite communication delay is considered between the agents. Under this condition, a novel output feedback control algorithm is developed. First, based on the hierarchical technique and Lyapunov-based time-domain method, the high-gain compensator and observer are constructed to tolerate the effect of infinite communication delays and accurately estimate the state of the leader. Subsequently, a new distributed k-filter and output feedback controller are proposed, which not only further relax the traditional Lipschitz conditional conservatism but also greatly simplify the design process. It is proved that the closed-loop system is globally stable and all agents can achieve consensus. Finally, the effectiveness of the proposed method is verified through the simulation of the single-link manipulators.

Antitrust Laws and Conditional Conservatism

Antitrust Laws and Conditional Conservatism

Quasi-Indexer Ownership and Conditional Conservatism: Evidence from Russell Index Reconstitutions *

Quasi-Indexer Ownership and Conditional Conservatism: Evidence from Russell Index Reconstitutions *