Adjusting Linear Information Models for the Asymmetric Timeliness of Earnings*

Abstract:     
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.

Keywords: Linear Information Model, Ohlson Model, Accounting Conservatism, Asymmetric Timeliness of Earnings, Basu (1997), Conditional Conservatism

JEL Classifications: G29, M41, M44, D82, G14

Working Paper Series