Accounting Conservatism and Bankruptcy Risk

Abstract:     
This study examines relations between accounting conservatism and bankruptcy risk, and presents evidence that unconditional and conditional conservatism help mitigate subsequent bankruptcy risk via their cash enhancing and earnings management constraining properties. Bankruptcy risk is in turn positively associated with subsequent unconditional conservatism and negatively associated with subsequent conditional conservatism, reflecting auditor and regulator monitoring and managerial career motives. These results are robust to alternative measures for bankruptcy risk, alternative measures for unconditional and conditional conservatism, their endogeneity, and other controls. Combined, these findings suggest that accounting conservatism influences and is influenced by bankruptcy risk, thus contributing to the literatures on conservatism, contracting, and bankruptcy. This study lends support to a traditional rationale for conservatism and helps to inform ongoing deliberations regarding conservatism’s role as a pervasive property and enduring central tenet of financial accounting.

Number of Pages in PDF File: 63

Keywords: accounting conservatism, bankruptcy risk, unconditional conservatism, conditional conservatism

JEL Classification: M41, G32, G33

working papers series