The Basu measure as an indicator of conditional conservatism: Evidence from U.K. earnings components

Following the work of Basu in 1997, the excess of the sensitivity of accounting earnings to negative share return over its sensitivity to positive share return (the Basu coefficient) has been interpreted as an indicator of conditional accounting conservatism. Although this interpretation is supported by substantial evidence that the Basu coefficient is associated with likely demands for conservatism, concerns have arisen that it may reflect factors not directly related to conservatism, and that this may adversely affect its validity as an indicator of that phenomenon. We argue that evidence on the validity of the Basu coefficient as an indicator of conditional conservatism can be obtained by disaggregating earnings into components, classifying those components by whether or not they are likely to be affected by conditional conservatism, and examining whether the Basu coefficient arises primarily from components likely to be affected by conditional conservatism. We implement this procedure for UK firms reporting under FRS 3: Reporting Financial Performance from 1992 to 2004. Although a substantial proportion of the Basu coefficient emanates from cash flow from operating and investing activities (CFOI), which cannot directly reflect accounting conservatism, its incidence across other components of earnings is predominantly within those components likely to be affected by conditional conservatism. Also, although the bias documented by Patatoukas and Thomas in 2009 is present in all of our aggregate earnings measures, it is heavily concentrated in the CFOI component of earnings and largely absent from components classified as likely to be affected by conditional conservatism. With the important caveat that researchers should test the robustness of their results to the exclusion of the element of the Basu coefficient due to cash flows, our findings are consistent with the conditional conservatism interpretation of the coefficient

Consistent estimation of conditional conservatism

In this paper, we propose an econometric model that presents three advantages in relation to the Basu model: (1) it is robust to the aggregation problem; that is, we prove that the Basu model produces inconsistent estimations of conditional conservatism and that this problem is solved with our proposal; (2) it can produce firm-specific measures of conservatism by using time-series; and (3) it completes the understanding of the intercept in the Basu model by breaking it down between unconditional conservatism and the reversion of the differences between market and book values of equity. In other words, we can provide firm-specific measures of both conditional and unconditional conservatism with the same model. We demonstrate all these theoretical assertions using simulated dataAccounting conservatism, Conditional conservatism, Unconditional conservatism, The Basu model, Aggregation effect

The Impact of Default Risk on the Basu Measure of Accounting Conservatism

We show, analytically and empirically, that there is a positive correlation between default risk and the Basu measure of conservatism: the higher the default risk, the higher the bias in the Basu measure. We use the insight provided by our analysis to construct an improved version of the Basu measure, the Default-Adjusted-Basu (DAB) measure. The DAB measure adjusts for the effects of default risk on the Basu measure. Using Distance-to-Default as a measure of default risk, we contend that the DAB measure can substantially reduce the bias caused by default risk, and hence is a more robust measure of accounting conservatism than the standard Basu measure. We demonstrate that once one adjusts for the distance-to-default, the Basu conservatism coefficient is no longer positively correlated with leverage

Migration, Transfers and Child Labor

We examine agricultural child labor in the context of emigration, transfers, and the abil-ity to hire outside labor. We start by developing a theoretical background based on Basu and Van, (1998), Basu, (1999) and Epstein and Kahana (2008) and show how hiring labor from outside the household and transfers to the household might induce a re-duction in children’s working hours. Analysis using Living Standards Measurement Survey (LSMS) data on the Kagera region in Tanzania lend support to the hypothesis that both emigration and remittances reduce child labor.child labor, emigration, transfers, Tanzania

Five-brane Calibrations and Fuzzy Funnels

We present a generalisation of the Basu-Harvey equation that describes membranes ending on intersecting five-brane configurations corresponding to various calibrated geometries.Comment: 20 pages, latex, v2: typos fixed and refs adde

On the impossibility of representing infinite utility streams

We show that, independently of the topology chosen on the set of all infinity utility streams, there is no Social Welfare Function preserving the von Weizsäcker’s overtaking criterion. With our proof we extend the impossibility result of Basu and Mitra