Placebo Tests of Conditional Conservatism

2015 ◽  
Vol 91 (2) ◽  
pp. 625-648 ◽  
Author(s):  
Panos N. Patatoukas ◽  
Jacob K. Thomas
Keyword(s):  
Time Series ◽  
Financial Reporting ◽  
Data Availability ◽  
Share Price ◽  
Higher Moments ◽  
Archival Studies ◽  
Cross Sectional ◽  
Asymmetric Timeliness ◽  
Conditional Conservatism ◽  
Measures Of Performance

ABSTRACT Basu (1997) proposes a measure of financial reporting conservatism based on asymmetry in the conditional earnings/returns relation. Patatoukas and Thomas (2011) show upward bias in this measure, because a placebo—lagged earnings—also exhibits similar asymmetry. Ball, Kothari, and Nikolaev (2013a) and Collins, Hribar, and Tian (2014) propose alternative explanations for the bias and offer revised measures to overcome the bias. However, we find that both revised measures remain substantially upward-biased. In particular, a placebo based on lagged share price mimics time-series and cross-sectional variation observed for the revised measures. More generally, we find biases in the asymmetric timeliness specification because earnings, accruals, and other measures of performance are often related to second and higher moments of the distribution of returns. In addition to suggesting that the asymmetric timeliness specification be used with caution, our study illustrates the useful role placebos can play in archival studies. Data Availability: Data are available from the sources identified in the text.

scholarly journals On Estimating Conditional Conservatism

2012 ◽  
Vol 88 (3) ◽  
pp. 755-787 ◽  
Author(s):  
Ray Ball ◽  
S. P. Kothari ◽  
Valeri V. Nikolaev
Keyword(s):  
Financial Reporting ◽  
Fixed Effects ◽  
Scale Effects ◽  
Data Availability ◽  
Omitted Variables ◽  
Firm Level ◽  
Cross Sectional ◽  
Asymmetric Timeliness ◽  
Conditional Conservatism ◽  
Fixed Effects Regression

ABSTRACT The concept of conditional conservatism (asymmetric earnings timeliness) has provided new insight into financial reporting and stimulated considerable research since Basu (1997). Patatoukas and Thomas (2011) report bias in firm-level cross-sectional asymmetry estimates that they attribute to scale effects. We do not agree with their advice that researchers should avoid conditional conservatism estimates and inferences from research based on such estimates. Our theoretical and empirical analyses suggest the explanation is a correlated omitted variables problem that can be addressed in a straightforward fashion, including fixed-effects regression. Correlation between the expected components of earnings and returns biases estimates of how earnings incorporate the information contained in returns. Further, the correlation varies with returns, biasing asymmetric timeliness estimates. When firm-specific effects are taken into account, estimates do not exhibit the bias, are statistically and economically significant, are consistent with priors, and behave as a predictable function of book-to-market, size, and leverage. Data Availability: Data are publicly available from sources identified in the article.

More Evidence of Bias in the Differential Timeliness Measure of Conditional Conservatism

2011 ◽  
Vol 86 (5) ◽  
pp. 1765-1793 ◽  
Author(s):  
Panos N Patatoukas ◽  
Jacob K Thomas
Keyword(s):  
Time Series ◽  
Stock Returns ◽  
Joint Effect ◽  
Data Availability ◽  
Cross Sectional ◽  
Conditional Conservatism ◽  
Empirical Regularities

ABSTRACT Despite the conceptual appeal and popularity of the differential timeliness (DT) measure of conditional conservatism proposed in Basu (1997), Dietrich et al. (2007) and Givoly et al. (2007) have identified considerable biases associated with that measure. We renew their call to avoid using the DT measure because it is affected unexpectedly by two empirical regularities—namely, scale is negatively related to (1) deflated mean earnings and (2) variance of stock returns. Even though these regularities are unrelated to conditional conservatism, their joint effect is substantial and pervasive. More importantly, prior findings regarding time-series and cross-sectional variation in differential timeliness are confounded by corresponding variation in these regularities. Data Availability: Data are publicly available from sources identified in the article.

International financial reporting standards and conservatism in the Association of Southeast Asian Nations countries

2018 ◽  
Vol 26 (4) ◽  
pp. 487-510 ◽  
Author(s):  
Marziana Madah Marzuki ◽  
Effiezal Aswadi Abdul Wahab
Keyword(s):  
Financial Reporting ◽  
Accounting Standards ◽  
Reporting Quality ◽  
Financial Reporting Quality ◽  
Content Type ◽  
Asymmetric Timeliness ◽  
Conditional Conservatism ◽  
Two Measures ◽  
Asean Countries ◽  
Laws And Regulations

Purpose The purpose of this paper is to investigate whether the convergence of IFRS in ASEAN countries resulted in an improvement in financial-reporting quality, and in particular with regards the degree of conditional conservatism of financial reporting. Then, the authors investigate whether the convergence to IFRS and the degree of conditional conservatism is influenced by corruption as a proxy for the strength of ASEAN jurisdiction legal and enforcement systems. Design/methodology/approach The sample of this study is based on 22,085 firm-year observations from three ASEAN countries, namely, Malaysia, Thailand and Singapore from 2008 to 2014. This study employs a panel least square regression to test the effect of IFRS on two measures of conservatism which are asymmetric timeliness and accrual-based loss recognition. The conservatism data are extracted from ORBIS, while data for corruptions are extracted from Corruption Perception Index (CPI) that was released by Transparency International. Findings This study finds Convergence of IFRS enhance conditional conservatism. The findings are robust for two measures of conservatism which are asymmetric timeliness and accrual-based loss recognition. The result on unconditional conservatism finds that IFRS reduce unconditional conservatism, which supports that the code-law structures of the ASEAN countries as characterized by unconditional conservatism is reduced after IFRS convergence. A further test indicates that corruption reduces conditional conservatism in more corrupt countries. Research limitations/implications This study focused on three ASEAN countries only, as they have consistent convergence dates to the IFRS. Therefore the result may not be generalized to other ASEAN countries. Practical implications The study provides implications to the regulators that IFRS enhance financial-reporting quality and reduce the randomness of decisions that are based on financial information as has been introduced by unconditional conservatism. Therefore it is important for the regulators to incorporate IFRS compliance into laws and regulations. Currently, IFRS compliance is not incorporated into laws and regulations for ASEAN countries, except for Malaysia. In Malaysia, Section 7 of the Financial Reporting Act 1997 (FRA) empowers the Malaysian Accounting Standards Board (MASB) to issue approved accounting standards for application in Malaysia. Under section 26D of the FRA, financial statements that are prepared or lodged with the Central Bank, Securities Commission or Registrar of Companies must comply with the standards issued by the MASB. Originality/value This paper extends the literature on the effect of IFRS on conservatism as it provides robust effect of IFRS on both conditional and unconditional conservatism. In addition, this study extends the literatures on the effect of corruptions in the relationship between IFRS and conditional conservatism.

Why do Restatements Decrease in a Clawback Environment? An Investigation into Financial Reporting Executives' Decision-Making during the Restatement Process

2015 ◽  
Vol 90 (6) ◽  
pp. 2515-2536 ◽  
Author(s):  
Jonathan S. Pyzoha
Keyword(s):  
Decision Making ◽  
Executive Compensation ◽  
Financial Reporting ◽  
Financial Statements ◽  
Data Availability ◽  
Archival Studies ◽  
Key Factors ◽  
Ex Post ◽  
Auditor Quality

ABSTRACT Prior archival studies find that firms that voluntarily adopted clawback policies have experienced a reduction in restatements. I experimentally examine this outcome by investigating the influence of two key factors (i.e., executive compensation structure and auditor quality) on financial reporting executives' (hereafter, “executives”) decision-making regarding a proposed restatement that will lead to a clawback of their incentives. I find that executives (i.e., CFOs, controllers, and treasurers) facing a lower quality auditor are less likely to agree with amending prior financial statements when a higher proportion of their pay is incentive-based. However, this tendency is reduced when executives face a higher quality auditor, indicating that higher quality auditors can act as effective monitors. My results identify an ex post unintended consequence of clawback regulation that could at least partially offset the benefits of the ex ante deterrent effects of clawbacks, and that could contribute to findings of less frequent restatements when clawback policies are in place. I discuss potential implications regarding the role of executives during restatement decisions and auditors' risk assessments in a clawback environment. Data Availability: Data are available from the author upon request.

Nonfinancial Stakeholder Orientation and Conditional Accounting Conservatism

2020 ◽  
Vol 23 (04) ◽  
pp. 2050031
Author(s):  
Qing Liao Burke ◽  
Mengying Wang ◽  
Yijia Eddie Zhao
Keyword(s):  
Financial Reporting ◽  
Agency Costs ◽  
Accounting Conservatism ◽  
Cross Sectional ◽  
Reporting Practices ◽  
Stakeholder Orientation ◽  
Conditional Conservatism ◽  
Increasing Trend

This study examines the relation between conditional accounting conservatism and nonfinancial stakeholder orientation. Using the staggered passage of constituency statutes to identify increases in nonfinancial stakeholder orientation, we document that firms report more conservatively after statute adoption. Cross-sectional analyses indicate the increase in conditional conservatism after statute enactment is more pronounced for firms with higher agency costs between shareholders and managers, and less pronounced for firms with customers that have greater bargaining strength. Collectively, our study sheds light on how the increasing trend of nonfinancial stakeholder orientation plays a role in shaping financial reporting practices.

scholarly journals Stock Price Contagion Effects of Low-Quality Audits at the Individual Audit Partner Level

2018 ◽  
Vol 38 (2) ◽  
pp. 151-178 ◽  
Author(s):  
Ferdinand A. Gul ◽  
Chee Yeow Lim ◽  
Kun Wang ◽  
Yanping Xu
Keyword(s):  
Financial Reporting ◽  
Stock Price ◽  
Personal Characteristics ◽  
Time Lapse ◽  
Share Price ◽  
Cross Sectional ◽  
Contagion Effects ◽  
Audit Firms ◽  
Stock Market Valuation ◽  
The Individual

SUMMARY We use Chinese audit partner data to show that partners associated with financial reporting fraud induce share price declines among non-fraudulent firms audited by the same audit partners. In cross-sectional analyses, we find that share price declines are more pronounced when low-quality partners (LQPs) failed to issue modified audit opinions during the period in question and when the LQPs were from one of the Top 10 audit firms. Additional analyses show that investors impose larger penalties on contagion firms when fraudulent firms are larger and the time lapse between sanction and fraud commitment is shorter. The personal characteristics of LQPs (except gender) do not cause a difference in market reaction to contagion firms. Overall, our results speak to the importance of audit partner identity to stock market valuation. JEL Classifications: M41; M42; M48.

scholarly journals Financial reporting quality following the corporate governance reforms: A conditional conservatism perspective

2021 ◽  
Vol 10 (2, special issue) ◽  
pp. 216-225
Author(s):  
Wan Adibah Wan Ismail ◽  
Iman Harymawan ◽  
Dian Agustia ◽  
Khairul Anuar Kamarudin
Keyword(s):  
Corporate Governance ◽  
Financial Reporting ◽  
Reporting Quality ◽  
Quality Of Reporting ◽  
High Quality ◽  
Asymmetric Timeliness ◽  
Conditional Conservatism ◽  
Corporate Governance Reforms ◽  
Governance Reforms

This study examines the quality of financial reporting during the period following the corporate governance reforms in Malaysia, as motivated by the importance of investors’ needs for high-quality financial reporting. Using the asymmetric timeliness of the earnings model, we analysed the sample of 6,819 firm-year observations of Malaysian listed companies from 2002 to 2011. The findings show evidence of the high quality of reporting following the corporate governance reforms. We found that firms have reported a more timely recognition of losses than gains in the post-reform period. Our results suggest that conditional conservatism has been prevalent during the period, and the results are robust even after conducting extensive specification tests. This study suggests that after the corporate governance reforms, Malaysian companies’ financial statements have been more reliable for investors in making investment decisions.

Tax Effects of Book-Tax Conformity, Financial Reporting Incentives, and Firm Size

2013 ◽  
Vol 12 (2) ◽  
pp. 1-25 ◽  
Author(s):  
K. Hung Chan ◽  
Kenny Z. Lin ◽  
Feng Tang
Keyword(s):  
Financial Reporting ◽  
Small Firms ◽  
Reporting Quality ◽  
Unintended Consequences ◽  
Data Availability ◽  
Policy Position ◽  
Cross Sectional ◽  
Tax Effects ◽  
Reporting Incentives ◽  
The Government

ABSTRACT This study employs a natural experiment to examine the tax effects of a change in the level of conformity between tax and financial reporting in China for firms with different financial reporting incentives. We find that in a full book-tax conformity system, firms with incentives to report higher book income pay significantly higher income tax (per dollar of sales) than do firms without the same incentives. Although we do not find similar evidence in a non-conformed system, we observe cross-sectional variation in taxes paid by firms of varying sizes: by exploiting non-conforming financial reporting rules to a greater extent, large firms pay proportionately lower taxes than do small firms. To improve financial reporting quality, many countries have adopted International Financial Reporting Standards (IFRS) that may affect book-tax reporting differences. Our results suggest that this policy alternative is less desirable from a tax perspective. Therefore, accounting standard setters and securities regulators around the world should consider not only how such a change is intended to benefit capital markets, but also what unintended consequences this policy choice might have for government revenue. Our results also strengthen the government policy position on giving more tax relief to small firms. Data Availability: All data are available from public sources.

Proactive Financial Reporting Enforcement: Audit Fees and Financial Reporting Quality Effects

2019 ◽  
Vol 95 (2) ◽  
pp. 167-197 ◽  
Author(s):  
Annita Florou ◽  
Serena Morricone ◽  
Peter F. Pope
Keyword(s):  
Financial Reporting ◽  
Financial Distress ◽  
Reporting Quality ◽  
Audit Fees ◽  
Data Availability ◽  
Financial Reporting Quality ◽  
Costs And Benefits ◽  
Cross Sectional ◽  
The Public ◽  
Sectional Analysis

ABSTRACT We examine the costs and benefits of proactive financial reporting enforcement by the U.K. Financial Reporting Review Panel. Enforcement scrutiny is selective and varies by sector and over time, yet can be anticipated by auditors and companies. We find evidence that increased enforcement intensity leads to temporary increases in audit fees and more conservative accruals. However, cross-sectional analysis across market segments reveals that audit fees increase primarily in the less-regulated AIM segment, and especially those AIM companies with a higher likelihood of financial distress and less stringent governance. On the contrary, less reliable operating asset-related accruals are more conservative in the Main segment and, in particular, those Main companies with stronger incentives for higher financial reporting quality. Overall, our study indicates that financial reporting enforcement generates costs and benefits, but not always for the same companies. JEL Classifications: K42; M41; M42; M48. Data Availability: Data are available from the public sources cited in the text.

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