Accounting conservatism and the profitability of corporate insiders

Abstract

We predict that accounting conservatism influences insiders' opportunities to speculate on good and bad news, and thus, insider trading profitability. We find that greater conditional (unconditional) conservatism is associated with lower (higher) insiders' profitability from sales. We find limited evidence that conservatism influences profitability from purchases. These findings are consistent with our hypotheses on the different informational roles of conditional and unconditional conservatism, and on the asymmetric influence of conservatism over the opportunities to speculate on good versus bad news. Our research design takes into consideration the endogenous nature of insiders' trading and conservatism. The results are robust to different measures of conservatism and a number of additional analyses. K E Y W O R D S conditional conservatism, insider trading sales and purchases, profitability from insider trading, unconditional conservatism J E L C L A S S I F I C AT I O N G30, M41

Intellectual Structure and Evolution of Accounting Conservatism Research: Past Trends and Future Research Suggestions

“…For instance, Chang et al (2013) argued that AC might hamper innovation performance, and managers might make less risky decisions due to market pressure. The studies also classified accounting conservatism into conditional and unconditional conservatism and discussed features of both (Khalilov and Osma 2020). In addition to these quantitative studies, several qualitative studies (Glover and Lin 2018) have also been conducted.…”

The impact of securities regulation on the information environment around stock-financed acquisitions

“…As an alternate proxy for earnings quality, we use Khan and Watts's (2009) firm-year measure of earnings conservatism, C-SCORE, which is based on the timely recognition of negative events in the firms' accounts. We adopt C-SCORE as a proxy for firms' information environment to the extent that numerous authors (e.g., LaFond and Watts, 2008;Francis et al, 2013;Khalilov and Osma, 2020;Lara et al, 2020) have shown that earnings conservatism is negatively related to information asymmetry. According to Francis et al (2013), accounting conservatism is a governance mechanism that reduces information asymmetry, thus mitigating agency costs (Zaher, Mohamed, and Basuony, 2020).…”

“…For this analysis, we use two proxies for earnings quality 14 : (i) signed discretionary accruals based on the performance and growth, ROA&SGadjusted model (as proposed by Collins et al, 2017), and (ii) Khan and Watts's (2009) firm-year accounting conservatism measure, C-SCORE. Measures of discretionary accruals and accounting conservatism have been using in the literature as proxies for financial reporting quality (e.g., Leuz et al, 2003;Ball and Shivakumar, 2005;Hutton, Marcus, and Tehranian, 2009;Francis et al, 2013;Khalilov and Osma, 2020;Lara et al, 2020;Zaher et al, 2020). Higher (lower) values of discretionary accruals (accounting conservatism) are associated with poorer quality of the firms' financial information.…”

Asymmetric information consolidation and price discovery: Inferring bad news from insider sales

“…Similarly, even though Agrawal and Cooper (2015) find weak evidence that top managers of firms misstating earnings sell more stock during the period of the misstatement, their evidence is strong when they classify insider sales on the severity of the misstatement. Firm accounting choices, like conditional conservatism (Khalilov & Osma, 2020) and accruals (Sawicki & Shreshtha, 2014), are also related to insider trades.…”

“…Similarly, in their survey of CFOs, Graham, Harvey, and Rajgopal (2005) find that managers delay bad news in the hope they may never have to disclose it if the firm's status improves. Recognizing that conditional conservatism is a mechanism for incorporating bad news early, Khalilov and Osma (2020) show that profitability of insider sales is lower in firms with higher levels of conditional conservatism. Unconditional conservatism, on the other hand, is associated with greater profitability from insider sales.…”