Debiasing the Measurement of Conditional Conservatism

Journal of Accounting Research Forthcoming

79 Pages Posted: 10 Jan 2020 Last revised: 10 Apr 2021

See all articles by Marc Badia

Marc Badia

IESE Business School

Miguel Duro

IESE Business School

Fernando Penalva

IESE Business School - University of Navarra; European Corporate Governance Institute (ECGI)

Stephen G. Ryan

New York University (NYU) - Leonard N. Stern School of Business

Date Written: April 4, 2021

Abstract

Basu’s [1997] measurement of conditional conservatism as the asymmetric timeliness of earnings underlies hundreds of studies. However, many subsequent studies cast doubt on the extent to which Basu’s measure captures conditional conservatism versus statistical biases or alternative constructs (collectively, “biases”), thereby questioning the validity of the inferences that empirical researchers draw from analyses using the measure. We modify Basu’s measure in four simple ways to remove these biases. Our key modification is the inclusion of interactive controls for return variance, a volatility proxy that captures Patatoukas and Thomas’ [2011] return variance effect and various sources of economic optionality and adjustment costs. This inclusion captures volatility-related effects on both the level of earnings and the sensitivity of earnings to returns, and it allows the magnitudes of these effects to vary with the sign of returns. We conduct validation analyses using placebo dependent variables, synthetic returns, and non-conditionally conservative earnings components that show our modified Basu measure is largely free of known biases. We further show that our measure is associated with contracting and other economic variables as predicted by theory. Our findings suggest that researchers can rely on our modified Basu measure to identify the determinants and effects of conditional conservatism.

Keywords: Conditional conservatism, Asymmetric timeliness

JEL Classification: C23, D21, G32, M4

Suggested Citation

Badia, Marc and Duro, Miguel and Penalva, Fernando and Ryan, Stephen G., Debiasing the Measurement of Conditional Conservatism (April 4, 2021). Journal of Accounting Research Forthcoming , Available at SSRN: https://ssrn.com/abstract=3506934 or http://dx.doi.org/10.2139/ssrn.3506934

Marc Badia

IESE Business School ( email )

Avenida Pearson 21
Barcelona, 08034
Spain
+34 932534200 (Phone)

Miguel Duro

IESE Business School ( email )

Avenida Pearson 21
Barcelona, 08034
Spain

Fernando Penalva (Contact Author)

IESE Business School - University of Navarra ( email )

Ave. Pearson 21
Barcelona, Barcelona 08034
Spain
932534200 (Phone)
932534343 (Fax)

HOME PAGE: http://www.iese.edu

European Corporate Governance Institute (ECGI) ( email )

c/o the Royal Academies of Belgium
Rue Ducale 1 Hertogsstraat
1000 Brussels
Belgium

Stephen G. Ryan

New York University (NYU) - Leonard N. Stern School of Business ( email )

44 West 4th Street, Suite 10-73
New York, NY 10012-1118
United States
212-998-0020 (Phone)

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