Conditional Conservatism and Firm Investment Efficiency

Abstract:     
Conservatism is expected (1) to improve the monitoring process over managerial investment decisions, decreasing investment in settings where managers are likely to over-invest, and (2) to facilitate the access to external financing at lower cost, increasing investment in settings where managers are likely to under-invest. We find that more conservative firms are less likely to over- and under-invest. In addition, given that prior studies link excess monitoring to inefficient risk taking, we also analyze this potential downside of conservatism. We find a positive association between conservatism and future profitability, and no evidence that more conservative firms invest in less risky projects. The results are robust to controlling for the possible endogeneity between investment and conservative accounting choices, financial reporting quality, and governance provisions.

Number of Pages in PDF File: 55

Keywords: Conditional conservatism, earnings asymmetric timeliness, investment efficiency, overinvestment, underinvestment

JEL Classification: G10, G31, M41

working papers series