Conservatism and stock price informativeness

Abstract

This paper examines how conservative financial reporting influences stock price informativeness, which is defined as the extent to which the current market price reflects future earnings information. Using the accuracy of the future earnings expectations embedded in the current equity price as a measure of stock price informativeness, I find that conservative reporting is positively associated with price informativeness. The results are robust to an alternative stock price informativeness measure, namely, specific return variation or price non-synchronicity. Furthermore, I also find that a greater positive association between conservatism and stock price informativeness is associated with (1) lower analyst coverage and decreased forecast dispersion, (2) greater bid-ask spreads and greater R&D, and (3) lower financial disclosure quality, supporting the argument that main channel by which conservatism improves stock price informativeness is its impact on the information environment. Overall, the evidence suggests that (1) conservatism improves stock price informativeness by improving the firm's information environment, and (2) the marginal benefit of improvement in stock price informativeness via conservatism is more pronounced in firms with poorer information environments. The results further confirm that conservatism substitutes for information environments in ensuring more accurate equity pricing.