Debiasing the Measurement of Conditional Conservatism

Abstract

Basu's ["The Conservatism Principle and the Asymmetric Timeliness of Earnings." Journal of Accounting and Economics 24 (1997): 3-37] measurement of conditional conservatism as the asymmetric timeliness of earnings underlies hundreds of studies. However, many subsequent studies cast doubt on the extent to which Basu's measure captures conditional conservatism versus statistical biases or alternative constructs (collectively, "biases"), thereby questioning the validity of the inferences that empirical researchers draw from analyses using the measure. We modify Basu's measure in four simple ways to remove these biases. Our key modification is the inclusion of interactive

Managerial myopia and the unintended real consequences of conditional conservatism

“…(2014) modification of the Basu (1997) model of conditional conservatism with returns as the proxy for news. In light of criticisms levied against Basu‐type models (e.g., Patatoukas and Thomas, 2011), Badia, Duro, Penalva, and Ryan (2021) propose several modifications that reduce potential biases present in Basu‐type models, with the most significant being to control for return variance. Table 9, Panel A presents the results of our estimation of the Collins et al.…”

“…Because our REM measure is a transformed residual, the biases described in Chen et al (2018) do not directly apply (p. 783). However, we follow their guidance for reducing potential bias when the dependent variable is transformed by including all first-stage regressors used in the construction of all the REM variables included in our aggregated measures into the second stage regres- A presents the association between conditional conservatism and REM using the Collins et al ( 2014) model with modifications suggested by Badia et al (2021). Panel B presents the association between conditional conservatism and REM with first-stage REM regressors included following Chen et al (2018).…”

“…To mitigate the concerns raised in prior studies, we utilize multiple conservatism measures and quartile-rank our main measure of conservatism to reduce the influence of measurement error. In robustness tests, we incorporate the following modifications suggested by Badia et al (2021) into our Collins et al (2014) model of conditional conservatism as additional measures to reduce potential bias: (1) fully interacted control for return variance, (2) fully interacted control for market-to-book value of assets, and (3) firm fixed effects. Our results remain robust to these modifications (see Section 6.2).…”

“…In Table 3, we provide evidence of a robust positive relation between asymmetric timely loss recognition and REM using the Collins et al (2014) modification of the Basu (1997) model of conditional conservatism with returns as the proxy for news. In light of criticisms levied against Basu-type models (e.g., Thomas, 2011), Badia, Duro, Penalva, andRyan (2021) propose several modifications that reduce potential biases present in Basu-type models, with the most significant being to control for return variance. Table 9, Next, we consider the effect of potential biases that may arise when using REM as the dependent variable in the tests of our hypotheses.…”

Firm's cost of debt firstly changes conservatism and then leads the choices of future diversification strategies: Evidence from Asian countries

“…This study selects the listed firms in capital markets implementing diversification strategies and financing their businesses with a higher cost of debt. Thus, firms have low conservatism when choosing their diversification strategies (Badia et al., 2021; Rodríguez‐Pérez & Van Hemmen, 2010). In other words, this study explains that firms finance their businesses and that new products and geographical innovations need incremental debt costs (Garrido‐Prada et al., 2019; Zúñiga‐Vicente et al., 2019).…”