alexa The Conservatism Principle and Asymmetric Timeliness of Earnings
Business & Management

Business & Management

Journal of Business & Financial Affairs

Author(s): Sudipta Basu

Abstract Share this page

Conservatism is interpreted to mean that accountants more frequently report current "bad news" about future cash flows in contemporaneous earnings than current "good news." Thus, earnings reported under GAAP should be more timely in reporting "bad news" about future cash flows than "good news." This paper, using the firm's stock return as a measure of news, shows that the contemporaneous association between earnings and negative returns is two to five times as large as the contemporaneous association between earnings and positive returns. It is also shown that the greater timeliness of earnings relative to cash flow measures is largely due to a greater sensitivity to concurrent negative returns. This result is consistent with accountants recording accruals conservatively. Another implication of conservatism is that negative earnings surprises are likely to be less persistent than positive earnings surprises, because earnings reports more bad news concurrently than good news, with the latter being spread over several periods. This is shown to be true empirically. It is predicted and found that earnings response coefficients are higher for positive earnings changes than for negative earnings changes, which is consistent with the market correcting for the difference in persistence in conservatively determined earnings. It is also found that the sensitivity of earnings to negative returns has more than quadrupled since 1980, while the sensitivity of earnings to negative returns has declined by two-thirds, suggesting that earnings measurement has become more conservative. Increases in accounting conservatism are found to be correlated with increases in auditor liability, but no causal inferences are drawn.

This article was published in Journal of Accounting and Economics and referenced in Journal of Business & Financial Affairs

Relevant Expert PPTs

Relevant Speaker PPTs

Relevant Topics

Peer Reviewed Journals
Make the best use of Scientific Research and information from our 700 + peer reviewed, Open Access Journals
International Conferences 2017-18
Meet Inspiring Speakers and Experts at our 3000+ Global Annual Meetings

Contact Us

© 2008-2017 OMICS International - Open Access Publisher. Best viewed in Mozilla Firefox | Google Chrome | Above IE 7.0 version