Accounting Conservatism and Firm Value: 1994 – 2021

Abstract

We explore the relationship between measures of accounting conservatism and firm value as measured by Tobin’s Q. It is generally regarded that accounting conservatism may have conflicting effects on firm value. On one hand, conservative accounting practices may reduce the probability of negative surprises, thus reducing informational asymmetries in contracting. On the other, conservative accounting practices may lead to a downward bias in firm valuation, making it more difficult for analysts to accurately forecast earnings. Controlling for a variety of confounding factors, we find that the relationship between accounting conservatism and firm value varies interestingly with time period and market sentiment. On balance our results suggest that the relationship between accounting conservatism and firm value can best be described as non-positive to weakly negative. An examination of the period around the Covid-19 pandemic using a difference-on-difference model suggests some softening of the potentially negative relationship between accounting conservatism and firm value. This research contributes to the extant literature by documenting dimensions of this important relationship that can only be explored in the context of a large panel dataset.

Keywords: Accounting conservatism, firm value, uncertainty, informational asymmetries

JEL Classification: M41, G32, G14