A New Approach to Measuring Accounting Conservatism and the Contribution of Accelerated Loss Recognition vs. Delayed Gain Recognition to Trends in Conservatism

Abstract:     
Prior studies examine trends in accounting conservatism using a variety of measures and find strong evidence that conservatism has increased over time. This trend could arise from more prompt recognition of losses or more delayed recognition of gains, but the contribution of loss versus gain recognition to the increased conservatism has received little attention. This difference is important, because loss and gains conservatism play distinct but complementary roles in contracting and stewardship. In this study, we propose a new conditional measure of conservatism based on the association of negative versus positive accruals with future changes in cash flows. We find that both gains recognition and loss recognition generally contribute to trends in conservatism. We also compare trends in conservatism in high-technology versus other industries. Differences in accounting rules and the use of stock option plans suggest that gains recognition could contribute to a rapid increase in high-tech firms’ conservatism. We find that conservatism has increased more rapidly in high-technology industries than in other industries, and that gains recognition indeed contributes more to this trend than loss recognition.

Keywords: conservatism, accruals, accruals quality, asymmetric recognition, conservatism measure, trend in conservatism, cointegration, accounting conservatism, quality of earnings, agency costs, contracting, stock options, compensation, financial reporting, accounting standard-setting

JEL Classifications: D82, M21, M41, M44, M52

Working Paper Series