Earnings Conservatism and Value Relevance Across the Business Cycle

Abstract

Prior research has demonstrated higher value relevance of current earnings during economic expansions relative to contractions. We largely attribute such a result to expected growth prospects being captured in the current earnings coefficient when a direct proxy for expected future earnings is omitted from the returns-earnings model. We demonstrate that the conservatism and value relevance of current earnings is actually higher during economic contractions when including a proxy for future earnings expectations. We further demonstrate that the value-relevance of expected future earnings is higher during expansions, when the association between historical accounting information and future growth opportunities likely weakens. Copyright (c) 2009 The Authors Journal compilation (c) 2009 Blackwell Publishing Ltd.

Lessons From Financial Crisis: Has Accounting in Central and Eastern Europe Become More Conservative?

“…There is generally a lack of research about accounting conservatism in transitional economies of Central and Eastern Europe, but some evidence can be Based on the theoretical arguments and empirical evidence presented earlier, it is assumed that level of conditional conservatism should be lower during periods of economic decline in comparison to periods of expansions for companies in Central and Eastern Europe. Our expectations differ from findings of Khurana et al 38 and Jenkins et al 39 . Namely, we anticipate that higher litigation risk and increased regulatory scrutiny during the period of crisis will not be significant factors of conservatism for companies in transitional bank-oriented countries of Central and Eastern Europe due to undeveloped capital market mechanisms.…”

Conservatism, SEC investigation, and fraud

“…Due to the occurrence of depressed stock prices during recessionary periods, the relation between contractions and conservatism has been shown to be positive due to increases in securities litigation. Likewise, Jenkins et al (2009) find the relation between the value relevance of current earnings and conservatism is higher during recessionary periods due to increases in downside risk. However, expansionary periods are often associated with increases in growth.…”

“…Following prior studies which have expanded the Basu (1997) model, (e.g., Lobo and Zhou, 2006;Jenkins et al, 2009), we integrate FRAUD it into an extension of the Basu (1997) model by interacting it with the variable, R it à RD it , which represents the incremental response of bad news to good news, to arrive at FRAUD it…”

Market-to-book ratio and conditional conservatism: firms’ voluntary expensing of employee stock options

“…Examples of unconditional conservatism include accounting depreciation that is greater than the actual depreciation of long-term assets, requirements for the immediate expensing of certain items which last beyond one period and historical cost accounting that prevents recording future benefits of positive net present value projects. Jenkins et al (2009Jenkins et al ( , p. 1044) even state "Unconditional conservatism refers to the reporting of conservative accounting numbers not conditioned on economic reality". Examples of conditional conservatism are how responsive the accounting system is to new negative information regarding their existing receivables, inventory and assets/liabilities in general.…”

“…However, Hsu et al's (2012) recent study supports it representing conditional conservatism. Nevertheless, it is the most commonly used proxy for conditional conservatism (Ball and Shivakumar, 2005;Beaver and Ryan, 2005;Pae et al, 2005;Ruddock et al, 2006;Jenkins et al, 2009). Therefore, this study uses AT to proxy for conditional conservatism and refers to it as a more short-term measure than the MTB-1 ratio, which is described in the second point below.…”