Are All Special Items Equally Special? The Predictive Role of Conservatism

48 Pages Posted: 18 Jul 2007 Last revised: 11 Jan 2009

See all articles by Richard M. Frankel

Richard M. Frankel

Washington University in Saint Louis - Olin Business School

Sugata Roychowdhury

Boston College

Date Written: December 22, 2008

Abstract

We predict the persistence of large negative special items based on expected accounting conservatism. Greater conservatism results in immediate recognition of anticipated future cash flow losses, leading to large negative special items that are highly associated with contemporaneous returns. If prompt loss recognition induces managers to terminate loss-producing projects earlier, then negative special items reported by more conservative firms should exhibit faster reversal. In contrast, if firms with lower expected conservatism enjoy greater flexibility in spreading the recognition of losses then they are apt to experience future losses associated with current special items, and consequently should exhibit lower reversal. We predict and find that negative special items of these firms are less closely tied to contemporaneous returns and are more persistent with respect to future net income. Additional analysis indicates that the variation in special-items persistence does not simply reflect variation in the persistence of all earnings components, nor is it restricted to firms that just meet or beat important earnings targets.

Keywords: asymmetric timeliness, differential timeliness, special items, special items persistence, earnings persistence, conservatism, strategic reporting, special items classification, CSCORE, predicted conservatism

JEL Classification: M41, M43, M44, G12

Suggested Citation

Frankel, Richard M. and Roychowdhury, Sugata, Are All Special Items Equally Special? The Predictive Role of Conservatism (December 22, 2008). Available at SSRN: https://ssrn.com/abstract=1001434 or http://dx.doi.org/10.2139/ssrn.1001434

Richard M. Frankel

Washington University in Saint Louis - Olin Business School ( email )

One Brookings Drive
Campus Box 1133
St. Louis, MO 63130-4899
United States

Sugata Roychowdhury (Contact Author)

Boston College ( email )

140 Commonwealth Avenue
Chestnut Hill, MA 02467
United States
617-552-1764 (Phone)

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