The Confounding Effect of Cost Stickiness on Conservatism Estimates
41 Pages Posted: 17 Aug 2012 Last revised: 8 Mar 2016
Date Written: June 24, 2015
Sales decreases affect earnings more than sales increases because of cost stickiness. We hypothesize that this correlated omitted variable constitutes a confounding effect in standard asymmetric timeliness models. Controlling for a piecewise linear effect of sales changes in these models decreases the measured asymmetric timeliness significantly and changes inferences about the average level of conservatism and the extent of cross-sectional variation in conservatism. Validation tests confirm that the asymmetry for sales changes is consistent with sticky costs and is distinct from conditional conservatism. Future empirical research on conditional conservatism should recognize the potential confounding effect of sticky costs.
Keywords: timely loss recognition, omitted variable bias, over-investment
JEL Classification: D21, D23, M40, M41, M46
Suggested Citation: Suggested Citation