More on Estimating Conditional Conservatism
Panos N. Patatoukas
University of California, Berkeley - Haas School of Business
Jacob K. Thomas
Yale School of Management
May 1, 2013
Basu (1997) proposes a measure of financial reporting conservatism based on asymmetry in the conditional earnings/returns relation, or differences between the separate relations observed for good and bad news subgroups. To explain the bias noted by Patatoukas and Thomas (2011), or PT, in the Basu measure, Ball, Kothari, and Nikolaev (2012), or BKN, propose a framework which decomposes returns and earnings into expected and unexpected components. Whereas BKN believe that bias arises because of the conditional relation between (a) expected earnings and expected returns, we extend their analysis to also consider relations suggested by their framework between (b) expected earnings and unexpected returns, (c) unexpected earnings and expected returns, and (d) unexpected earnings and unexpected returns. We find that the first relation, between the expected components of earnings and returns, does not create bias in the Basu measure, contrary to BKN’s claim. But we find biases, both positive and negative, in the remaining three relations. The bias we document for the second relation is equivalent to the PT explanation for their bias. The bias we document for the fourth relation suggests that the revised Basu measures proposed by BKN are unreliable.
Number of Pages in PDF File: 48
Keywords: Conditional Conservatism, Asymmetric Timeliness, Expected Earnings, Expected Returns
JEL Classification: M41working papers series
Date posted: June 23, 2013
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