Abstract

http://ssrn.com/abstract=1923489
 
 

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Financial Distress and the Earnings‐Sensitivity‐Difference Measure of Conservatism


Audrey Wen‐Hsin Hsu


affiliation not provided to SSRN

John O'Hanlon


Lancaster University - Department of Accounting and Finance

Ken V. Peasnell


Lancaster University - Department of Accounting and Finance

September 2011

Abacus, Vol. 47, Issue 3, pp. 284-314, 2011

Abstract:     
Following Basu (1997), the difference between the sensitivity of accounting earnings to negative equity return (proxy for bad news) and its sensitivity to positive equity return (proxy for good news) is interpreted as an indicator of conditional accounting conservatism. However, there is concern that the earnings‐sensitivity difference (ESD) may be affected by factors other than conditional conservatism, and that this may impair its reliability as an indicator of conditional conservatism. Motivated by such concerns and by recognition that financial distress could contribute to an ESD through a conditional‐conservatism route and/or through a non‐conditional‐conservatism route, we examine the association between financial distress and the ESD for U.S. non‐financial firms. By decomposing the association into an element arising from accruals, which can reflect conditional conservatism, and an element arising from cash flow from operating activities (CFO), which cannot directly reflect conditional conservatism, we seek evidence as to whether such association arises through a conditional‐conservatism route or through a non‐conditional‐conservatism route. We find that positive association between financial distress and the ESD arises predominantly through the accruals component of earnings rather than the CFO component, consistent with it arising primarily because of a higher degree of conditional conservatism in relatively financially distressed firms. The inference that there is a positive association between financial distress and conditional conservatism is supported by other non‐equity‐return‐based measures of conditional conservatism. The evidence in this paper suggests that the effect of financial distress does not significantly impair the reliability of the ESD as an indicator of conditional conservatism.

Number of Pages in PDF File: 31

Keywords: Accounting, Asymmetric timeliness, Conditional conservatism, Conservatism, Financial distress

Accepted Paper Series


Date posted: September 7, 2011  

Suggested Citation

Wen‐Hsin Hsu, Audrey and O'Hanlon, John and Peasnell, Ken V., Financial Distress and the Earnings‐Sensitivity‐Difference Measure of Conservatism (September 2011). Abacus, Vol. 47, Issue 3, pp. 284-314, 2011. Available at SSRN: http://ssrn.com/abstract=1923489 or http://dx.doi.org/10.1111/j.1467-6281.2011.00342.x

Contact Information

Audrey Wen‐Hsin Hsu
affiliation not provided to SSRN
No Address Available
John F. O'Hanlon (Contact Author)
Lancaster University - Department of Accounting and Finance ( email )
The Management School
Lancaster LA1 4YX
United Kingdom
+44 1524 593631 (Phone)
+44 1524 847321 (Fax)
Kenneth V. Peasnell
Lancaster University - Department of Accounting and Finance ( email )
The Management School
Lancaster LA1 4YX
United Kingdom
+44 1524 593631 (Phone)
+44 1524 847321 (Fax)
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References:  49
Footnotes:  10

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