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Asymmetric Timeliness of Earnings, Market-to-Book and Conservatism in Financial Reporting

56 Pages Posted: 20 Dec 2004  

Sugata Roychowdhury

Boston College

Ross L. Watts

Massachusetts Institute of Technology (MIT) - Sloan School of Management

Date Written: January 2006

Abstract

When annual earnings are regressed on annual returns, the returns coefficient is higher when returns are negative. The difference between the coefficients of earnings on positive and negative returns is called asymmetric timeliness of earnings and, in the accounting literature, is used extensively as a conservatism measure. The objective of this paper is to investigate the relation between asymmetric timeliness and the market-to-book ratio (MTB), using a theory of accounting conservatism that reflects the role of accounting as observed in practice. Recent literature has focused on the negative relation between the two measures. Using our theory of conservatism, we predict and observe empirically that the relation between asymmetric timeliness over a period and MTB at the end of the period is positive when asymmetric timeliness is measured cumulatively over long horizons. Our paper further highlights that when asymmetric timeliness is measured over short periods not including the firm's IPO, it is dependent on the composition of equity value at the beginning of that period. This dependence is responsible for the negative association observed between asymmetric timeliness estimated over short periods and MTB at the end of the period. Our theory and empirical results further suggest that asymmetric timeliness is a better measure of total conservatism at a point in time when it is estimated cumulatively over multiple years preceding that time. Overall, our results are consistent with our theory that accounting does not record changes in rents and is asymmetrically timely in recording changes in separable asset values.

Keywords: Conservatism, asymmetric timeliness, accruals, earnings management, international accounting, executive compensation, debt financing

JEL Classification: M41, M43, M44, M47, G12, G34, G35, J33

Suggested Citation

Roychowdhury, Sugata and Watts, Ross L., Asymmetric Timeliness of Earnings, Market-to-Book and Conservatism in Financial Reporting (January 2006). MIT Sloan Research Paper No. 4550-05; Simon Business School Working Paper No. FR 04-21. Available at SSRN: https://ssrn.com/abstract=638001 or http://dx.doi.org/10.2139/ssrn.638001

Sugata Roychowdhury (Contact Author)

Boston College ( email )

140 Commonwealth Avenue
Chestnut Hill, MA 02467
United States
617-552-1764 (Phone)

Ross L. Watts

Massachusetts Institute of Technology (MIT) - Sloan School of Management ( email )

E52-325
Cambridge, MA 02142
United States

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