Conditional Conservatism in Accounting: New Measure and Tests of Determinants

Following Basu’s (1995, 1997) seminal work, accounting literature adopted the Basu coefficient to measure conditional conservatism (among others, Ball et al. 2003; Ball et al. 2000; Ball et al. 2005; Ball and Shivakumar 2005; Lobo and Zhou 2006; Chandra et al. 2004). However, Basu’s choice of proxy for measuring the arrival of good/bad news, stock returns, introduces inaccuracy in the measure of conditional conservatism (Dietrich et al. 2007; Roychowdhury and Watts 2007; Givoly et al. 2007). To address the problem, I introduce a new measure of conditional conservatism, which results from a Least Absolute Deviation (LAD) piecewise regression and adopts the number of changes in financial analysts’ EPS forecasts as a proxy for good/bad news about future earnings and extends the analysis to two-year and three-year time horizons. I use this new measure to test three determinants that prior literature suggested to explain the presence of accounting conservatism. Results show that companies with (1) high debt-to-assets ratio – closer to default on their debt covenants, with large portion of executives’ compensation tied to the firm’s performance, and in the year prior to a going concern opinion from their auditors report aggressively, recognizing future good news in annual earnings more quickly than bad news

Conditional Conservatism in Accounting: New Measures and Test of Determinants of the Asymmetric Timeliness in the Recognition of Good and Bad News in Reported Earnings

Accounting standards mandate different, more conservative, rules for the recognition of unrealized gains than unrealized losses in reported earnings. Conditional conservatism, defined as asymmetric timeliness in the recognition of unrealized losses vs. gains in reported earnings has, since its origins, been a peculiar characteristic of the accounting system. Understanding conservatism’s role, its determinants, and its variations across firms is important for interpreting the nature, purposes, and valuation implications of accounting. Basu (1995; 1997) proposed a model to detect accounting conditional conservatism and provided empirical evidence that bad news is recognized more quickly than good news in earnings for a sample over the period 1963-1991. Following his seminal work1, accounting literature adopted the Basu single-period model to measure conditional conservatism (Ball et al. 2000; Ball et al. 2005; Ball and Shivakumar 2005; Lobo and Zhou 2006). However, Basu’s proxy for measuring the arrival of good/bad news, the price of the firm’s stock, may be influenced, in part, by factors that will never be recorded in a firm’s reported earnings. This introduces inaccuracy in the measure of conditional conservatism. To address the problems, I introduce a new measure of conditional conservatism, which results from a Least Absolute Deviation (LAD) piecewise regression and adopts the number of changes in financial analysts’ EPS forecasts as a proxy for good/bad news. Then, I use this new measure to test the determinants, suggested by previous literature, of conditional conservatism in accounting. Results show that companies with (1) lower debt-to-assets ratio, (2) large proportion of executives’ annual compensation independent of the firm’s accounting performance, (3) one of the big 4/big 7 audit firms as auditor, and a auditor opinion qualified with a going concern assumption the previous year exhibit a greater timeliness in the recognition of bad news than good news in annual earnings. ____________________ 1As of December 7, 2006, 102 citations for Basu (1997) are recorded on Thomson ISI’s Social Sciences Citation Index (http://portal.isiknowledge.com) and 291 are on Google Scholar (http://scholar.google.com

The Effect of Corporate Governance Regulatory Intervention on Firm Decisions and Market Reactions, the Italian Case

This paper investigates whether Italian companies that cross-list in the United States between 1993 and 2005 show (i) a change in their internal policies as anticipated by the bonding hypothesis, (ii) an increase in market value, or (iii) an increase in the access to capital funds. We use the unique environment created by the 1998 Draghi reform which significantly improved the protection of Italian listed companies’ minority shareholders and we further examine the impact of legislated changes in corporate governance in Italy on the decision of Italian companies to cross-list in the United States. Our results indicate that following the Draghi reform (i) firms that cross-list in the United States modify their dividend and cash policies as anticipated by the bonding hypothesis. Contrary to prior research, (ii) we do not find evidence that cross-listing serves to enhance shareholder value or (iii) is used as a vehicle to more easily access capital funds either before or after the domestic corporate governance is improved. The results of this study provide evidence that country level legislative innovations intended to enhance a weak corporate governance system can be a valid and effective substitute to the bonding mechanism by providing an alternative signal of a firm’s quality

Managing Exchange Rates

The collapse of the fixed exchange rate system established under the Bretton Woods Agreement ushered in fluctuating exchange rate regimes. Although extreme volatility is managed by monetary authorities, fluctuations in exchange rates present unique challenges to the manager of a multinational corporation (MNC). This chapter reviews various types of exchange rate regimes and discusses the types of risk an MNC faces due to exchange rate fluctuations. Special attention is paid to how these risks are measured and ways in which they are hedged using available financial market instruments. The chapter also discusses exchange rate forecasting models that are frequently used

Living up to your codes? Corporate codes of ethics and the cost of equity capital

Purpose Previous literature provides mixed evidence about the effectiveness of a code of ethics in limiting managerial opportunism. While some studies find that code of ethics is merely window-dressing, others find that they do influence managers\u27 behavior. The present study investigates whether the quality of a code of ethics decreases the cost of equity by limiting managerial opportunism. Design/methodology/approach In order to test the hypothesis, the authors perform an empirical analysis on a sample of US companies in the 2004–2012 period. The results are robust to a battery of robustness analyses that the authors performed in order to take care of endogeneity. Findings Empirical results indicate that a higher quality code of ethics is associated with a lower cost of equity. In other words, firms with a more comprehensive code of ethics and better-designed implementation procedures limit managerial opportunism and pay a lower cost of equity because they are perceived by investors to be less risky. Research limitations/implications Practical implications Social implications Originality/value The authors contribute to the literature in two ways. First, by looking at the market reaction to the code of ethics, thus capturing all its indirect possible benefits and second, by measuring not only the existence but also the quality of a code of ethics. Based on the results, policymakers may choose to further promote codes of ethics as an effective corporate governance mechanism

Living Up to Your Codes? Corporate Codes of Ethics and the Cost of Equity Capital

Purpose- Previous literature provides mixed evidence about the effectiveness of a code of ethics in limiting managerial opportunism. While some studies find that code of ethics is merely window-dressing, others find that they do influence managers\u27 behavior. The present study investigates whether the quality of a code of ethics decreases the cost of equity by limiting managerial opportunism. Design/methodology/approach- In order to test the hypothesis, the authors perform an empirical analysis on a sample of US companies in the 2004–2012 period. The results are robust to a battery of robustness analyses that the authors performed in order to take care of endogeneity. Findings- Empirical results indicate that a higher quality code of ethics is associated with a lower cost of equity. In other words, firms with a more comprehensive code of ethics and better-designed implementation procedures limit managerial opportunism and pay a lower cost of equity because they are perceived by investors to be less risky. Research limitations/implications- Practical implications- Social implications- Originality/value- The authors contribute to the literature in two ways. First, by looking at the market reaction to the code of ethics, thus capturing all its indirect possible benefits and second, by measuring not only the existence but also the quality of a code of ethics. Based on the results, policymakers may choose to further promote codes of ethics as an effective corporate governance mechanism

Programas de PhD nos Estados Unidos

As Department Chairperson at The University of Texas at El Paso, I am often asked for advice regarding how to become an accounting professor. Recently, the University attained R1 designation in the Carnegie Classification of Institutions of Higher Education, which indicates top tier doctoral university status with very high research activity (“UTEP Attains National Research Top Tier Ranking”, 2019). This means UTEP is among 4.5%, 130 out of 2,883 universities, of four-year higher education institutions across the United States to earn this R1 distinction (“UTEP Attains National Research Top Tier Ranking”, 2019). This emphasis on research, UTEP’s mission surrounding Access and Excellence, and my own path to becoming an accounting professor were the catalyst behind an editorial geared towards international students interested in exploring a Ph.D. in the United States. We believe the role of an accounting professor is comprised of: 1.) enriching the global business and accounting community through research contributions, 2.) facilitating career readiness to students seeking higher education, and 3.) serving as an ambassador and advocate for students, programs, profession, and research. We hope this editorial helpful and we encourage you to create your own success story.Como chefe de departamento da Universidade do Texas, em El Paso, sou frequentemente solicitado a dar conselhos com relação a como se tornar professor de Contabilidade. Recentemente, a universidade alcançou a designação R1 na Classificação Carnegie de Instituições de Ensino Superior, a qual indica o ranking superior das 10 universidades com doutorados com elevadas atividades de pesquisa, (“UTEP Attains National Research Top Tier Ranking”, 2019). Isso significa que o UTEP está entre as 4,5%, 130 de 2.883 universidades, instituições de quatro anos de educação superior dentro dos Estados Unidos a receber essa distinção R1 (“UTEP Attains National Research Top Tier Ranking”, 2019). A distinção R1 também é detida por universidades como Stanford, M.I.T., Michigan, Arizona, California-Berkeley e UT Austin (“UTEP Attains National Research Top Tier Ranking”, 2019). Levado a essa designação R1, o programa de Contabilidade obteve reafirmação do AACSB Business Accreditation and AACSB Accounting Accreditation. Essa ênfase em pesquisa, a missão da UTEP envolvendo Acesso e Excelência e meus próprios passos para tornar-me professor em Contabilidade foram os catalizadores por trás do editorial focado nos estudantes internacionais interessados em explorar um Ph.D, nos Estados Unidos. Eu começo minha jornada rumo a um Ph.D em Contabilidade

Discontinued SEC Required Disclosures: the Value of Repairs and Maintenance Expenditures using a Variance Decomposition Approach

On December 13, 1994, the Securities and Exchange Commission (SEC) eliminated certain schedules that included repairs and maintenance (R&M) disclosures previously required in annual reports and registration statements filed with the SEC. The purpose of this research is to determine if market participants utilized R&M information when making investment decisions. Resulting from a variance decomposition approach, the findings indicate that market participants did use R&M disclosures in their investment decisions. Thus, as a possible policy implication of this research, the SEC may want to reconsider the decision to eliminate the required R&M expenditure disclosures

Language in Economics and Accounting Research: The Role of Linguistic History

This paper investigates whether a consideration of linguistic history is important when studying the relationship between economic and linguistic behaviors. Several recent economic studies have suggested that differences between languages can affect the way people think and behave (linguistic relativity or Sapir–Whorf hypothesis). For example, the way a language obliges one to talk about the future might influence intertemporal decisions, such as a company’s earnings management. However, languages have historical relations that lead to shared features—they do not constitute independent observations. This can inflate correlations between variables if not dealt with appropriately (Galton’s problem). We discuss this problem and provide an overview of the latest methods to control linguistic history. We then provide an empirical demonstration of how Galton’s problem can bias results in an investigation of whether a company’s earnings management behavior is predicted by structural features of its employees’ language. We find a strong relationship when not controlling linguistic history, but the relationship disappears when controls are applied. In contrast, economic predictors of earnings management remain robust. Overall, our results suggest that careful consideration of linguistic history is important for distinguishing true causes from spurious correlations in economic behaviors