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Accounting Conservatism and the Efficient Provision of Capital to Privately Informed Firms

Michael J. Smith

Boston University School of Management

June 27, 2011

This study addresses conservatism in financial reporting. Firms seek financing for an investment. Investors have access to an imperfect accounting signal that may also have a conservative tendency. If the firms have no private information, conservatism is desirable only for negative ex ante expected value investments, consistent with the spirit of the results of Gigler et al (2009) and other studies. Conservatism is not optimal for positive expected value investments because it denies financing to too many of them. If firms have private information, however, conservatism may be desirable even for positive expected value investments. Conservatism is useful in this setting because it increases the probability that privately informed good firms will be able to distinguish themselves from bad firms. Otherwise, good firms prefer not to invest and the financing market fails.

Number of Pages in PDF File: 50

Keywords: accounting, conservatism, asymmetric information

JEL Classification: M41, M44, G31

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Date posted: June 28, 2011  

Suggested Citation

Smith, Michael J., Accounting Conservatism and the Efficient Provision of Capital to Privately Informed Firms (June 27, 2011). Available at SSRN: http://ssrn.com/abstract=1873449 or http://dx.doi.org/10.2139/ssrn.1873449

Contact Information

Michael J. Smith (Contact Author)
Boston University School of Management ( email )
595 Commonwealth Avenue
Boston, 02215
United States
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