Conservative Accounting Practices Research Articles

Effects of presidential elections on accounting conservatism: Evidence from South Korea

AbstractThis study examines the effects of presidential elections (PEs) on firms’ accounting conservatism in Korea. The Korean president exerts great influence on the government's financial, monetary, subsidiary, and regulatory policies. At the same time, however, the Korean constitution prohibits the re‐election of the incumbent president. This simultaneously strong and fragile presidential system creates unique political uncertainty, which deteriorates the information gap between firms’ insiders and outsiders. According to the efficient contracting channel, accounting conservatism is expected to relieve information asymmetry by recognizing the economic losses faster than economic gains. But we posit that the effectiveness of accounting conservatism depends on the information environment within which they operate. If the information environment facilitates a compensation system for an increase in accounting conservatism under high uncertainty, managers may prefer to expand conservative accounting practices. However, if there is no such incentive mechanism, managers may opt to suspend accounting conservatism because the cost of revealing bad news increases during periods of uncertainty. Test results show that PEs encourage managers to delay rather than expedite the timely recognition of economic losses. This negative effect becomes more pronounced in firms with higher reliance on government contracts than firms with lower such reliance. We also find that Korean chaebol‐affiliated firms are likely to increase accounting conservatism during PEs. In general, US‐based studies support the positive relationship between information asymmetry and accounting conservatism, while this study demonstrates that this relationship can be reverse depending on the institutional environment.

الأثر المعدل للتحفظ المحاسبي على العلاقة بين عدم تماثل المعلومات وتكلفة رأس المال: دراسة تطبيقية على الشركات الصناعية المدرجة في بورصات دول مجلس التعاون الخليجي

The aim of this study is to identify the moderating effect of accounting conservatism on the relationship between information asymmetry and cost of capital. Since this issue is almost neglected in the emerging markets, especially in the Arab countries, the study uses data belongs to the industrial companies listed on the exchanges of the Gulf Cooperation Council (GCC) countries covering the 2015-2021 period. The results show that accounting conservatism moderates the positive effect of information asymmetry on the cost of capital. Therefore, companies may reduce cost of capital by decreasing information asymmetry and enhancing the use of conservative accounting practices. In particular, the level of disclosure and the efficiency of governance should be enhanced. Regulators can significantly contribute in this regard by issuing relevant regulations and improving the oversight over companies. Finally the study provides insights to be considered in the future research.

The effect of corporate reputation on accounting conservatism

This study examines the impact of corporate reputation on accounting conservatism. We argue that firms with valuable reputations are likely to select conservative accounting practices as a form of insurance to protect their reputations. We document strong evidence that companies with high reputations—those included on Fortune's “Most Admired Companies” list—employ more conservative accounting than firms not on the list. We also investigate a hand-collected sample of firms with product recalls. Accounting conservatism appears to offset the negative stock price effect of product recalls, and high-reputation firms appear to benefit substantially more from conservative accounting than control firms.

Impact of Accounting Conservatism on Income Smoothing: Empirical Evidence from Algeria

Abstract This paper investigates the impact of accounting conservatism on income smoothing as a proxy for accounting manipulation. The study used 993 observations for 133 Algerian companies from 2012 to 2020, where income smoothing was measured by the variations in cash flows relative to earnings. However, conservatism was measured through non-operating accounting accruals, accruals-to-earnings ratio before extraordinary items, and allowances. The results showed that total accruals do not impact income smoothing versus positive impacts from non-operating accruals and allowances to income smoothing. Therefore, the study concluded that accounting conservatism facilitates income smoothing in Algerian companies by extending the discretionary room available for managers to manipulate earnings. These results require accounting regulators to consider the role of conservatism in manipulation when setting or amending accounting standards. They also imply that auditors should give more attention to conservative accounting practices to limit the opportunistic behavior of managers and increase the reliability of financial information.

Does climate risk disclosure shape conservatism? The role of earnings quality in the Egyptian context

The objectives of this study are to (i) examine the relationship between accounting conservatism and climate-related risk disclosure (CRRD) in the context of Egypt, and (ii) look into the moderating role of earnings quality (EQ) in such a relationship. To operationalize CRRD reported by Egyptian firms listed in the SP/EGX ESG index across the years from 2018 to 2022, the study uses a manual content analysis as a base for analysis and employs two (OLS) regression models to test the study’ hypotheses. EQ is measured using the cross-sectional modified Jones model, while accounting conservatism is gauged using the C-Score. Additionally, endogeneity checks in robustness tests are performed using system GMM. The findings show no impact of CRRD on the conservative accounting practices of Egyptian firms. However, there is a sizable adverse effect when EQ is used to moderate this association. This finding is consistent with the notion that firms report high levels of climate impacts and have fewer information asymmetry issues. This paper extends disclosure indexes by highlighting the frequent keywords of CRRD used in the annual narrative reports of Egyptian firms. Hence, this study is among the first to explore the moderation impact of EQ on the relationship between CRRD and accounting conservatism in the Egyptian setting.

The Effect of Accounting Conservatism, Capital Intensity on Tax Avoidance with Independent Commissioners as Moderating Variables

This research aims to provide light on how accounting conservatism and capital intensity influence tax avoidance, and how the existence of independent commissioners acts as a moderators component in this connection. This study employs a causal quantitative methodology. This research focuses on 21 energy-related firms trading on the Indonesian Stock Exchange between 2017 and 2021. The sample size is 105, and it was determined using a basic random sampling technique. Linear regression analysis and moderated regression analysis were employed for the data analysis (MRA). This research shows that conservative accounting practices and high levels of capital intensity help taxpayers avoid paying their fair share of taxes. Moreover, independent commissioners can mitigate the impact of accounting conservatism on tax avoidance, but cannot do so for the impact of capital intensity.

The relationship between investment and accounting conservatism: a study applied to small and medium-sized Portuguese companies

Conservatism has been present in accounting practice for a long time. Currently, the dichotomy between historical cost and fair value or between the qualitative characteristic of relevance and reliability motivate further research. Thus, in this paper we analyse whether the level of investment affects conditional conservatism in Portuguese small and medium-sized entities over the period from 2014 to 2018. The study was based on the econometric model proposed by Basu (1997), modified by Ball and Shivakumar (2005). The results indicate that these firms in general do not opt for conservative accounting practices. However, firms that report investment activities tend to be more conservative aiming at capturing investors’ confidence. Furthermore, the empirical evidence does not allow us to conclude that extreme levels of investment significantly affect conservatism. This study contributes to the debate on the relevance of conservative accounting practice at the level of investment decisions.

Effects of air pollution on accounting conservatism

We examine the impact of air pollution on a firm's accounting policy conservatism. We hypothesize that, in response to risks associated with increased air pollution, firms apply more conservative accounting practices and utilize more conservative estimates in their reporting. Using a sample of Chinese firms, accounting conservatism measures, and a satellite-based air pollution metric, we confirm the validity of our hypothesis. Additional analysis suggests that the impact of air pollution on accounting policy conservatism is more salient for firms in high-pollution industries, firms under severe financial constraint, firms with higher environmental risk, and firms that receive high media coverage. Further, we document that air pollution does not significantly affect a firm's return on assets, year-on-year sales growth, or Tobin's Q measure. Hence, it is management's risk perception, not objective performance concern, that is driving accounting conservatism. Finally, specifically investigating accounting conservatism, we discover that, for firms with higher pollution levels, selling general and administrative expenses, liabilities provision, accrued expenses, and asset impairment loss are significantly higher.

IMPACT OF LEVERAGE AND FINANCIAL DISTRESS ON ACCOUNTING CONSERVATISM

This study objective is to determine whether and how exposure to financial stress and leverage can prompt accountants to exercise greater caution when working with numerical data. The investigation covered 165 manufacturing companies that were scheduled to be listed on the Indonesia Stock Exchange in 2020. For the purpose of this study, a purposive sampling technique was utilized to select a total of 52 different companies at random. The records of the company's finances that have been audited are the source of the secondary data. The approach taken in this study is primarily based on the use of quantitative methods. SPSS version 26's descriptive statistics, multiple linear regression, analysis requirements, classical assumption, and hypothesis testing features were utilized in order to conduct the analysis on the collected data. According to the findings of the study, there is no statistically significant connection between financial hardship and conservative accounting practices. Leverage does not significantly alter the cautious nature of accounting. Moreover, the combined effects of financial distress and leverage have little to no visible influence on the conservative accounting process.

Earnings management and stock price crashes post U.S. cross-delistings

We examine whether cross-delisted firms from the major U.S. stock exchanges experience an increase in crash risk associated with earnings management. Consistent with our prediction, we find that earnings management has a greater positive impact on stock price crash risk post cross-delisting when compared to a control group of firms that remain cross-listed. More importantly, we find that this effect is more pronounced for cross-delisted firms from countries with weaker investor protection, poorer quality of their information environment and less conservative accounting practices. Our findings are robust to the potential endogenous nature of the cross-delisting decision, alternative measures of stock price crash risk and information asymmetry. We interpret our results as evidence of a “reverse bonding effect” following cross-delistings from U.S. stock exchanges.

Conservative Accounting, Audit Quality, and Litigation

Investors are much more likely to sue corporations and their auditors for overstated earnings reports than for understated reports. This asymmetry in litigation exposure is viewed as an important driver for conservative accounting practices in corporations because conservatism reduces the probability of overstatements and hence, investor litigation. This argument is incomplete, however, because it ignores that litigation concerns also affect the incentives of the auditor, which, in turn, affect the firm’s optimal reporting system. We find that the threat of litigation encourages firms to report more conservatively only when the auditor’s cost of detecting misstatements is relatively high but promotes less conservative reporting when the auditor’s cost of auditing is low. This paper was accepted by Brian Bushee, accounting

Accounting conservatism and firm performance during the COVID‐19 pandemic

We explore whether firms with more conditionally conservative accounting practices have higher stock returns than other firms during the Covid‐19 outbreak. We find evidence that Chinese firms listed on the Shanghai and Shenzhen Stock Exchanges applying more conditionally conservative reporting have lower declines in stock return performance during the Covid‐19 outbreak relative to other firms. We also find that the beneficial role of conditional conservatism is higher when firms have greater information asymmetry following the Covid‐19 pandemic. Our results are robust to various model specifications with four different measures of conservatism and an alternative return window.

The effect of bank governance on borrowers’ accounting choices

ABSTRACT This study analyzes the effect of bank CEO appointment structure and tenure on borrowers’ accounting practices and earnings management. Drawing on agency theory, we posit that agency costs are high for banks that frequently change CEOs and those that appoint CEOs from external sources. The results indicate firms that borrow from banks with high agency costs adopt less conservative accounting practices and employ real activities earnings management when deteriorating management conditions lead to negative cash flow. This study provides a strong empirical foundation for future research by verifying that appointment structure and tenure of bank CEOs affect borrowers’ accounting choices.

Conservatism, Earnings Quality, and Stock Prices - Indonesian Evidence

Research aims: This research investigates the association of conservatism (both conditional and unconditional) with quality of earnings as well as with stock prices on companies listed on the Indonesia Stock Exchange (IDX).Design/Methodology/Approach: The research uses a sample of 846 observations of publicly listed companies on the Indonesian Stock Exchange for the fiscal year that ends on December 31, 2016 through 2018. Conditional conservatism is measured by using an asymmetric timeliness measure from Basu (ATMB). Net income ratio (CFO/NI) is a proxy for earnings quality whereas ratio between market value and book value (MTB) is a measure of unconditional conservatism. The data used in this study are obtained both from Indonesian Stock Exchange database, and from company annual reports.Research findings: The study finds that all companies analyzed implement conservative accounting policies and practices. Besides, quality of earnings and stock prices are negatively associated with conditional conservatism. This research also proves that stock price negatively associated with unconditional conservatism, whereas unconditional conservatism does not associated with earnings quality.Theoretical contribution/ Originality: This study enriches the existing literature about conservatism, especially in emerging market environment. Moreover, this study discusses a set of conservatism that consist of conditional and unconditional conservatism. This may give a complete picture of conservatism practices adopted by Indonesian companies.Practitioner/Policy implication: Since conservatism can solve agency cost problems, the result of this study may affect the way a company produce useful information for interest parties.Research limitation/Implication: The use of the purposive sampling method limits generalizations, because sample designs could not be assumed to characterize all companies listed on IDX.

Target Firm Accounting Conservatism and Corporate Acquisitions: Transferring Wealth or Benefiting Both?

Because conservative accounting practices induce firms to report bad news earlier and defer good news disclosure, accounting conservatism in target firm accounting can hinder acquirers from identifying a potentially profitable target while it can help acquiring firms mitigate the downside risk stemming from future asset write-downs and investment inefficiency. After controlling for other accounting attributes and governance mechanisms, our analysis reveals that a firm is more likely to receive an acquisition offer when its financial reporting is more conservative. More importantly, while an acquirer’s acquisition performance turns out to be greater when the target firm’s accounting is more conservative, the acquirer and other investors pay larger takeover premiums to a more conservative target firm. Overall, our findings suggest that unlike other target firm accounting quality proxies that transfer wealth from the target to the acquirer shareholders, target firm accounting conservatism benefits the shareholders of both the acquirer and the target.

CEOs’ experience of the Great Chinese Famine and accounting conservatism

AbstractThis study investigates how a CEO's early‐life experience of the Great Chinese Famine affects corporate accounting conservatism. We find that companies whose CEOs had experienced famines in early life adopted more conservative accounting policies. This famine experience effect is more pronounced in high uncertainty environments proxied by non‐SOEs, politician turnovers and the adoption of International Financial Reporting Standards (IFRS). Additional tests indicate that CEOs with famine experience tend to support conservative accounting practices for contingencies and accelerate the recognition of asset impairments in negative events. Overall, consistent with imprinting theory, our results highlight the role of early‐life traumatic experiences in shaping CEOs’ risk preferences and financial reporting policies.

The Effect of Economic Conditions on Accounting Conservatism under IFRS in Europe

Abstract We analyse in detail conservative accounting practices in seventeen European countries, taking into account institutional factors. In addition, we examine the impact of IFRS adoption and the influence of changes in economic conditions on conditional conservatism. Specifically, we study the level of accounting conservatism before and after IFRS adoption detailing for the pre and crisis period and post-crisis period surrounding the 2007/2008 financial crisis. Our findings are consistent with a conservative accounting practice in Europe as a whole and in each country individually. Besides, opposite to that expected, the results provide evidence of more conservative accounting practice in Anglo-Saxon countries, but we find no significant differences in conservatism in Nordic countries. Another finding is a significant decrease in the level of conservatism after IFRS adoption. Regarding the joint impact of IFRS adoption and economic conditions, we find a decrease in conservatism in the pre and crisis period, followed by a substantial increase in the post-crisis period. Our results seem to be in line with the positive accounting theory when suggesting that conservatism plays a fundamental role as corporate governance and efficient contracting mechanism between managers and other stakeholders of the firm. Furthermore, the results suggest that the flexibility provided by IFRS allows adjusting the level of conservatism when economic conditions change.

Do Family Firms Choose Conservative Accounting Practices?

We investigate whether family firms are motivated to adopt conservative accounting practices, given their unique characteristics of high promoter holdings, less diversified equity, and long-term interest in the business. We examine whether heterogeneity within family firms, captured through family members’ involvement in management and the firm’s affiliation to a business group, drives conservative behavior. We test our model on a sample of 2534 listed Indian firms from 2006 to 2015. Our results indicate that family-controlled firms are more conditionally conservative in their accounting practices, especially when family members manage them and when they are affiliated with a business group. These findings are robust to alternative measures of conservatism and also after controlling for omitted variable bias and reverse causality.

Accounting Conservatism and Asset Price

This paper presents a static model of a competitive securities market. In the market there are two assets: risk-free asset and risky asset. The payoff of the risk-free asset is one and the payoff of the risky asset is unknown. Rational traders correctly estimate the mean and variance of the risky asset payoff. Earnings fixated traders are functionally fixated on accounting earnings numbers. Due to the conservative accounting practices, earnings fixated traders underestimate the mean and variance of the risky asset payoff. Noise traders' demand for the risky asset is assumed to be random. This paper proves analytically that the presence of accounting conservatism decreases the asset price and the volatility of the asset price and it increases the expected return of the asset. In addition, this paper proves that the presence of accounting conservatism decreases the likelihood of the asset price lying on the right tail of its distribution and depending on the model parameter values, the presence of accounting conservatism may increase or decrease the likelihood of the asset price lying on the left tail of its distribution.

The effect of SOX on audit quality

Purpose This paper aims to investigate two issues. First, the authors test the effect of the Sarbanes–Oxley Act (SOX) on audit quality after 10 years. Second, the authors test whether it was necessary to close all of the Arthur Andersen offices due to the misbehavior of a few (e.g. the Houston and Atlanta offices). Design/methodology/approach The authors have used conservatism (Basu) as a proxy for audit quality. Findings The authors find that, over the long run (10 years) after SOX adoption, there is a significant positive change in conservatism as compared to during the previous similar period. In addition, the authors find that only 6 of the 20 city-level offices of Arthur Andersen were less conservative than were their other Big 6 competitors in the same city. Furthermore, the results also suggest that some city-level offices of Arthur Andersen were engaged in more conservative accounting practices than were their competitors and the Houston Andersen offices. Originality/value This study documents, using empirical evidence, that the implementation of SOX is successful, and that one factor that helped lead to this success might be the harsh punishment on Arthur Andersen.