How Timely are Earnings When Costs are Sticky? Implications for the Link Between Conditional Conservatism and Cost Stickiness

Abstract

We interpret cost stickiness, i.e., the manager's decision to bear the costs of unutilized resources when sales decline, as a risky project and examine its impact on conditional conservatism. We find that cost stickiness increases the asymmetric timeliness of earnings by weakening the timeliness of earnings for good news firms and, at the same time, intensifying the timeliness of earnings for bad news firms. Additionally, the results suggest that the asymmetric timeliness of earnings for cost sticky firms is more strongly driven through accounting factors, as reflected in accruals than through non-accounting factors, as reflected in cash flow. Our results imply that cost stickiness is more costly due to conditional conservatism and that the market separates the efficient from the inefficient cost sticky firms indicating that information asymmetry is low. Future research could test whether conditional conservatism helps mitigating the information asymmetry induced by cost stickiness.

Keywords: Accounting Conservatism, Asymmetric Timeliness of Earnings, Basu (1997), Conditional Conservatism, Cost Stickiness

JEL Classification: M40, M41, M44, M46, D82, G14