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Identifying Conditional Conservatism in Financial Accounting Data: Theory and Evidence

50 Pages Posted: 7 Jun 2015 Last revised: 3 Jun 2017

Sunil Dutta

University of California, Berkeley - Haas School of Business

Panos N. Patatoukas

University of California, Berkeley - Haas School of Business

Date Written: October 6, 2016

Abstract

Using a financial reporting and valuation model, we investigate the construct validity of Basu’s (1997) asymmetric timeliness (AT) regression coefficient as a measure of conditional conservatism in corporate financial reporting. We predict that the AT coefficient will be positive even in the absence of conditional conservatism and it will vary with non-accounting factors even if the degree of conditional conservatism is held constant. Our empirical analysis shows that AT coefficient estimates vary in directions predicted by our theory. Specifically, we find that AT coefficient estimates increase with expected returns and asymmetry in the distribution of returns, and decrease with cash flow persistence. Importantly, we identify the spread between the variances of bad news and good news accruals as an alternative measure of conditional conservatism that is free of the effects confounding the AT coefficient. Consistent with a key implication of conditional conservatism, we find that the variance of bad news accruals is significantly higher than the variance of good news accruals primarily due to conditionally conservative accruals related to inventory write-downs, long-term asset write-downs, and goodwill impairments. A series of placebo tests provides additional support for the construct validity of our alternative measure of conditional conservatism.

Keywords: conditional conservatism, asymmetric timeliness, loss recognition, corporate financial reporting, valuation, construct validity, placebo tests

JEL Classification: M40, M41, G12

Suggested Citation

Dutta, Sunil and Patatoukas, Panos N., Identifying Conditional Conservatism in Financial Accounting Data: Theory and Evidence (October 6, 2016). Accounting Review, Forthcoming. Available at SSRN: https://ssrn.com/abstract=2615205 or http://dx.doi.org/10.2139/ssrn.2615205

Sunil Dutta

University of California, Berkeley - Haas School of Business ( email )

545 Student Services Building, #1900
2220 Piedmont Avenue
Berkeley, CA 94720
United States
510-643-1229 (Phone)
510-643-1412 (Fax)

Panos N. Patatoukas (Contact Author)

University of California, Berkeley - Haas School of Business ( email )

545 Student Services Building, #1900
2220 Piedmont Avenue
Berkeley, CA 94720
United States

HOME PAGE: http://sites.google.com/site/panossom/

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