Lagged Earnings Asymmetry in a Firm-Year Measure of Accounting Conservatism

Journal of Financial Reporting, Forthcoming

Georgia Tech Scheller College of Business Research Paper No. 18-34

48 Pages Posted: 4 Sep 2018

See all articles by Bruce K. Billings

Bruce K. Billings

Florida State University - Department of Accounting

James Moon

Georgia Institute of Technology - Scheller College of Business

Richard M. Morton

Florida State University - Department of Accounting

Date Written: August 2018

Abstract

Khan and Watts (2009) develop a firm-year measure of conditional conservatism, labeled C_Score, that builds on the Basu (1997) asymmetric timeliness (AT) measure. However, recent research documents an asymmetric relation between lagged earnings and current returns, indicative of bias in the Basu measure. We demonstrate that this lagged earnings asymmetry (LEA) taints C_Score by mimicking (i.e., overstating) C_Score’s relation to nearly all of the firm characteristics used by KW as validation tests. Thus, LEA represents an alternative interpretation for hypotheses tests involving C_Score as a measure of conditional conservatism. We examine two very distinct explanations for LEA identified in prior research and demonstrate that controlling for both is necessary and sufficient to yield a modified C_Score measure that is uncorrelated with LEA. We conclude that while LEA identifies a threat to the usefulness of C_Score as a firm-year measure of conservatism, the underlying causes of LEA can be adequately addressed.

Keywords: Conditional Conservatism, Firm-Year Measure, Lagged Earnings Asymmetry, Bias

JEL Classification: M41, M44, G34, G38, K22, D82

Suggested Citation

Billings, Bruce K. and Moon, James and Morton, Richard M., Lagged Earnings Asymmetry in a Firm-Year Measure of Accounting Conservatism (August 2018). Journal of Financial Reporting, Forthcoming; Georgia Tech Scheller College of Business Research Paper No. 18-34. Available at SSRN: https://ssrn.com/abstract=3238198

Bruce K. Billings

Florida State University - Department of Accounting ( email )

Rovetta Business Bldg. (RBA)
College of Business
Tallahassee, FL 32306-1110
United States
850-644-7889 (Phone)
850-644-8234 (Fax)

James Moon (Contact Author)

Georgia Institute of Technology - Scheller College of Business ( email )

800 West Peachtree St.
Atlanta, GA 30308
United States

Richard M. Morton

Florida State University - Department of Accounting ( email )

Room No. 421
Tallahassee, FL 32306-8234
United States
850-644-7877 (Phone)

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