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Conditional Conservatism in Accounting: New Measure and Tests of Determinants

48 Pages Posted: 12 Mar 2008 Last revised: 7 May 2008

Giorgio Gotti

University of Texas at El Paso (UTEP)

Date Written: February 2008

Abstract

Following Basu's (1995, 1997) seminal work, accounting literature adopted the Basu coefficient to measure conditional conservatism (among others, Ball et al. 2003; Ball et al. 2000; Ball et al. 2005; Ball and Shivakumar 2005; Lobo and Zhou 2006; Chandra et al. 2004). However, Basu's choice of proxy for measuring the arrival of good/bad news, stock returns, introduces inaccuracy in the measure of conditional conservatism (Dietrich et al. 2007; Roychowdhury and Watts 2007; Givoly et al. 2007).

To address the problem, I introduce a new measure of conditional conservatism, which results from a Least Absolute Deviation (LAD) piecewise regression and adopts the number of changes in financial analysts' EPS forecasts as a proxy for good/bad news about future earnings and extends the analysis to two-year and three-year time horizons.

I use this new measure to test three determinants that prior literature suggested to explain the presence of accounting conservatism. Results show that companies with high debt-to-assets ratio - closer to default on their debt covenants, with large portion of executives' compensation tied to the firm's performance, and in the year prior to a going concern opinion from their auditors report aggressively, recognizing future good news in annual earnings more quickly than bad news.

Keywords: Conditional conservatism, earnings forecasts, financial analysts, Basu coefficient

JEL Classification: M41, M44, G29

Suggested Citation

Gotti, Giorgio, Conditional Conservatism in Accounting: New Measure and Tests of Determinants (February 2008). Available at SSRN: https://ssrn.com/abstract=1105083 or http://dx.doi.org/10.2139/ssrn.1105083

Giorgio Gotti (Contact Author)

University of Texas at El Paso (UTEP) ( email )

500 West University Avenue
El Paso, TX 79968-0542
United States

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