Conservatism and Endogenous Preferences - An Experimental Approach

Literature suggests that individuals have endogenous preferences for accounting conservatism as compared to neutral accounting due to intrinsic loss aversion (Hirshleifer and Teoh, 2009; Nagar et al., 2016). However, no empirical evidence for this claim exists. This thesis addresses a call for more research on irrational preferences for conservative accounting (Hirshleifer and Teoh, 2009) by providing first experimental insights on individuals’ endogenous preferences for conservative compared to neutral accounting. Accounting conservatism is characterized by demanding higher verification requirements for gains than losses (Watts, 2003a), resulting in a more timely recognition of losses than gains (Basu, 1997). By considering potential future losses up-front, users of accounting information are protected from future disappointment, thereby accounting for individuals’ intrinsic loss aversion (Hirshleifer and Teoh, 2009). Although being a fundamental accounting concept, conservatism has increasingly become a controversial issue. In recent years, standard setters have followed a critical view arguing that conservatism results in biased information, concealing true performance. They currently put forward neutral, i.e. symmetric accounting (IASB, 2010, CF; IASB, 2015, CF ED) with the objective of providing accounting information that is more useful to users. In the experiment conducted in this thesis, the case of accounting for research and development (R&D) expenditures serves as an example for variants of different degrees of conservatism. Immediate expensing of R&D expenditures is a typical example for conservative accounting (Beaver and Ryan, 2005). Capitalizing R&D expenditures, on the other hand, represents neutral accounting by symmetrically matching the investment outlay with the future benefits derived from the investment. Participants are in their investor role and make investment decisions in a judgment (between-subjects design) as well as a choice setting (within-subjects design). Results support expectations: individuals show preferences for conservative relative to neutral accounting – especially after prior loss experiences. Evidence suggests that conservatism can better address individuals’ loss aversion. Mentally processing potential losses is more comfortable under conservative than under neutral accounting. These insights contribute to the ongoing discussion on accounting conservatism by establishing that a disregard for peoples’ endogenous preferences for conservatism associated with neutral accounting can have detrimental economic consequences, such as a lower willingness to invest in firms applying neutral accounting

Conservatism and Endogenous Preferences - An Experimental Approach

Literature suggests that individuals have endogenous preferences for accounting conservatism as compared to neutral accounting due to intrinsic loss aversion (Hirshleifer and Teoh, 2009; Nagar et al., 2016). However, no empirical evidence for this claim exists. This thesis addresses a call for more research on irrational preferences for conservative accounting (Hirshleifer and Teoh, 2009) by providing first experimental insights on individuals’ endogenous preferences for conservative compared to neutral accounting. Accounting conservatism is characterized by demanding higher verification requirements for gains than losses (Watts, 2003a), resulting in a more timely recognition of losses than gains (Basu, 1997). By considering potential future losses up-front, users of accounting information are protected from future disappointment, thereby accounting for individuals’ intrinsic loss aversion (Hirshleifer and Teoh, 2009). Although being a fundamental accounting concept, conservatism has increasingly become a controversial issue. In recent years, standard setters have followed a critical view arguing that conservatism results in biased information, concealing true performance. They currently put forward neutral, i.e. symmetric accounting (IASB, 2010, CF; IASB, 2015, CF ED) with the objective of providing accounting information that is more useful to users. In the experiment conducted in this thesis, the case of accounting for research and development (R&D) expenditures serves as an example for variants of different degrees of conservatism. Immediate expensing of R&D expenditures is a typical example for conservative accounting (Beaver and Ryan, 2005). Capitalizing R&D expenditures, on the other hand, represents neutral accounting by symmetrically matching the investment outlay with the future benefits derived from the investment. Participants are in their investor role and make investment decisions in a judgment (between-subjects design) as well as a choice setting (within-subjects design). Results support expectations: individuals show preferences for conservative relative to neutral accounting – especially after prior loss experiences. Evidence suggests that conservatism can better address individuals’ loss aversion. Mentally processing potential losses is more comfortable under conservative than under neutral accounting. These insights contribute to the ongoing discussion on accounting conservatism by establishing that a disregard for peoples’ endogenous preferences for conservatism associated with neutral accounting can have detrimental economic consequences, such as a lower willingness to invest in firms applying neutral accounting

Conservatism and Endogenous Preferences - An Experimental Approach

Literature suggests that individuals have endogenous preferences for accounting conservatism as compared to neutral accounting due to intrinsic loss aversion (Hirshleifer and Teoh, 2009; Nagar et al., 2016). However, no empirical evidence for this claim exists. This thesis addresses a call for more research on irrational preferences for conservative accounting (Hirshleifer and Teoh, 2009) by providing first experimental insights on individuals’ endogenous preferences for conservative compared to neutral accounting. Accounting conservatism is characterized by demanding higher verification requirements for gains than losses (Watts, 2003a), resulting in a more timely recognition of losses than gains (Basu, 1997). By considering potential future losses up-front, users of accounting information are protected from future disappointment, thereby accounting for individuals’ intrinsic loss aversion (Hirshleifer and Teoh, 2009). Although being a fundamental accounting concept, conservatism has increasingly become a controversial issue. In recent years, standard setters have followed a critical view arguing that conservatism results in biased information, concealing true performance. They currently put forward neutral, i.e. symmetric accounting (IASB, 2010, CF; IASB, 2015, CF ED) with the objective of providing accounting information that is more useful to users. In the experiment conducted in this thesis, the case of accounting for research and development (R&D) expenditures serves as an example for variants of different degrees of conservatism. Immediate expensing of R&D expenditures is a typical example for conservative accounting (Beaver and Ryan, 2005). Capitalizing R&D expenditures, on the other hand, represents neutral accounting by symmetrically matching the investment outlay with the future benefits derived from the investment. Participants are in their investor role and make investment decisions in a judgment (between-subjects design) as well as a choice setting (within-subjects design). Results support expectations: individuals show preferences for conservative relative to neutral accounting – especially after prior loss experiences. Evidence suggests that conservatism can better address individuals’ loss aversion. Mentally processing potential losses is more comfortable under conservative than under neutral accounting. These insights contribute to the ongoing discussion on accounting conservatism by establishing that a disregard for peoples’ endogenous preferences for conservatism associated with neutral accounting can have detrimental economic consequences, such as a lower willingness to invest in firms applying neutral accounting