Identifying Accounting Conservatism in the Presence of Skewness

Abstract

We show analytically that the asymmetric timeliness (AT) coefficient in the Basu (1997) model is not a reliable measure of accounting conservatism in the presence of skewness in returns and/or earnings. Using an extensive simulation-based approach, we clarify the exact conditions under which asymmetry in the distribution of both returns and earnings adversely affects the AT coefficient. While earnings skewness is a predicted consequence of conditional conservatism, return skewness is arguably unrelated to conservative reporting. Return skewness therefore distorts the AT coefficient as a measure of conservatism, which cannot be tackled by simple skew reducing transformations. Empirically, we provide evidence that cross-sectional variation in the AT coefficient is correlated with cross-sectional variation in skewness.

Keywords: conditional conservatism; asymmetric timeliness; piecewise linear regression; skewness

JEL Classification: M41, C15