Litigation Cost, Market-to-Book, and Asymmetric Timeliness of Earnings

International Journal of Finance and Accounting Studies Vol. 1 No. 1; April 2013

17 Pages Posted: 1 Oct 2013

See all articles by Zhefeng Frank Liu

Zhefeng Frank Liu

Brock University

Daniel B. Thornton

Smith School of Business at Queen's University

Fayez A. Elayan

Brock University-Goodman School of Business

Multiple version iconThere are 2 versions of this paper

Date Written: September 29, 2013

Abstract

Recent studies have questioned the validity of the Basu asymmetric timeliness of earnings (AT) as the proxy for accounting conservatism. An important basis for the criticism is the negative association observed between AT and market-to-book ratio (MB), another proxy for conservatism. Drawing upon prior research, we hypothesize and find that the negative relationship is stronger in a more litigious environment, indicating that low MB is a proxy for elevated expected litigation cost. Therefore the negative association reflects the rational response of managers and auditors in applying greater conservatism to mitigate expected litigation cost that increases as MB dips below a threshold. The negative association is not a valid basis for questioning the validity of the Basu model. This study demonstrates that MB is a proxy for risk, contributing to the debate on whether book-to-market ratio is a proxy for risk or the product of mispricing in the finance literature.

Keywords: Market-to-book, Book-to-market, Litigation, Asymmetric timeliness, Basu model, Conditional conservatism, Unconditional conservatism, Private Securities Litigation Reform Act

Suggested Citation

Liu, Zhefeng Frank and Thornton, Daniel B. and Elayan, Fayez A., Litigation Cost, Market-to-Book, and Asymmetric Timeliness of Earnings (September 29, 2013). International Journal of Finance and Accounting Studies Vol. 1 No. 1; April 2013. Available at SSRN: https://ssrn.com/abstract=2333043

Zhefeng Frank Liu (Contact Author)

Brock University ( email )

st catharines, Ontario
Canada
(905)688-5550 ext 5834 (Phone)

Daniel B. Thornton

Smith School of Business at Queen's University ( email )

143 Union Street, #358
Kingston, Ontario K7L 3N6
Canada
613-328-5213 (Phone)
613-533-2321 (Fax)

HOME PAGE: http://smith.queensu.ca

Fayez A. Elayan

Brock University-Goodman School of Business ( email )

1812 Sir Issac Brock Way
St. Catharines, Ontario L2S 3A1
Canada
905-688-5550 (Phone)
905-688-9779 (Fax)

HOME PAGE: http://www.brocku.ca

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