Does accounting conservatism pay?

We investigate whether or not there is a link between conservative accounting practices and the sensitivity of executive pay to accounting performance. Using several accrual‐based measures of accounting conservatism as well as alternative measures of accounting performance, we estimate an econometric model of CEO compensation that incorporates the interaction of accounting conservatism and accounting performance. Consistent with optimal contracting theory, we find that the sensitivity of executive pay to accounting performance is higher for firms that report conservative accounting earnings. These results support the hypothesis that accounting conservatism, by limiting earnings management opportunities and improving the reliability of accounting performance measures, allows firms to formulate contracts that tie executive compensation more closely to accounting performance.     

Does banking deregulation affect accounting conservatism?

This study examines the effect of banking competition on borrowing firms’ conditional accounting conservatism (i.e., asymmetric timely loss recognition). The context of the study is the staggered passage of the Interstate Banking and Branching Efficiency Act (IBBEA), the deregulation that permits banks to establish branches across state lines and increases bank competition. I find that firms report less conservatively after the passage of the IBBEA in their headquarter states. The effect on conditional conservatism is stronger for firms in states with a greater increase in competition among banks, firms that are more likely to borrow from in-state banks, firms with greater financial constraint, and firms subject to less external monitoring. Additional tests confirm that the decline in conditional conservatism is observed only after the adoption of IBBEA and lasts for two years. The findings indicate that banks tend to “lowball” borrowers when competition arises by relaxing their demand for conservative reporting. Overall, this study highlights the unintended impacts of banking competition on borrowing firms’ financial reporting.     

Does auditor tenure affect accounting conservatism? Further evidence

Accounting regulators are concerned about the potential threat of long-term auditor–client relationships on auditor independence, leading to lower audit quality. Jenkins and Velury (2008, hereafter JV) document a positive association between the conservatism in reported earnings and the length of the auditor–client relationship. A primary objective of this study is to extend JV by providing evidence that the relationship between conservatism and auditor tenure is not unique for all firms. In particular, this study finds that the positive association only exists for large firms or firms strongly monitored by their auditors, while for smaller firms or firms weakly monitored by their auditors, I observe a significantly negative association between auditor tenure and conservatism.     

Does accounting conservatism improve the corporate information environment?

This study investigates whether and how accounting conservatism improves the corporate information environment. We argue that conservatism facilitates the flow of firm-specific information from corporate insiders to outsiders and leads to a high-quality information environment. Using the Basu (1997) model to capture the extent of accounting conservatism and firm-specific return variation to proxy for the quality of information environment, we find that conservatism is positively associated with the improvement of the corporate information environment in our sample of 43 countries. We also find that the information role of conservatism is more pronounced in countries with weaker protection of private property rights, suggesting that conservatism substitutes for legal institutions in ensuring the quality of information environment.     

Do short sellers anticipate late filings?

Exploiting the setting of firms that are unable to disclose timely financial reports and thus must file with the U.S. Securities and Exchange Commission (SEC) the NT 10-K (Q) report, this study examines whether short sellers target firms with financial reporting weaknesses. We find that short interest increases in firms prior to the NT 10-K (Q) filing, suggesting that short sellers identify and target firms that cannot file their financial reports in a timely manner. Short selling is positively significantly related to subsequent late filing status, and is more pronounced in late filers with high newswire activity and with accelerated filing deadlines. Short selling of late filing firms is significantly negatively related to subsequent performance thereby suggesting that short sellers' trades pertinent to late filers are profitable. Overall, the results underscore a high information processing ability of short sellers in the setting of firms that exhibit financial reporting deficiencies.     

Can short sellers constrain aggressive non-GAAP reporting?

Review of Accounting Studies - Prior research finds an association between short selling volume and aggressive non-GAAP earnings disclosures but does not explore whether increased short selling...     

Are corporate governance attributes associated with accounting conservatism?

This article investigates the association between the board of directors, the audit committee and the external auditor (as well as an aggregate governance index) and the extent of conservatism evident in Australian firms’ financial reporting. Overall, the results provide only weak evidence that firms with certain governance characteristics report more conservatively. Evidence of any such link is restricted to measures of board composition and leadership, and even then the results are sensitive to the method used to measure the extent of conservatism in financial reporting.     

How do institutional investors influence accounting conservatism in China?

Using a sample of Chinese listed firms from 2003 to 2015, we find that domestic mutual funds have negative effects while qualified foreign institutional investors (QFIIs) have positive effects on firm accounting conservatism. These effects become stronger when their ownerships are closer to that of the controlling shareholder, respectively. Furthermore, these results are more pronounced when institutional investors are more able to monitor managers and compete with controlling shareholders. Our findings suggest that the influence of institutional investors on accounting conservatism in China is subject to their identities as well as the control contestability against the controlling shareholders.     

Whose opinion matters when insiders disagree with short sellers?

This study investigates the credibility of conflicting trading signals from two well-informed and sophisticated parties: corporate insiders and short sellers. Our results suggest that insiders’ information is dominant when short sellers trade in the opposite direction. We attribute the positive price reaction following a disagreement to insiders’ superior information that is not available to short sellers. Our results do not support the managerial short-termism argument. Two additional tests show that insider buying credibility enhances when information asymmetry is high and that short sellers reverse their shorting position after the disclosure of insider buying. Both findings support the idea that short sellers may experience a previously unacknowledged barrier in accessing private information.     

Are short sellers incrementally informed prior to earnings announcements?

Contrary to the hypothesis that informed short sellers increase their positions prior to earnings announcements, we find that short activity declines in the pre-announcement period compared with activity in non-announcement time. This statistically significant, but economically modest, decline may suggest that the fraction of informed short sellers actually increases if (as Diamond and Verrecchia (1987) suggest) the uncertainty around earnings announcements increases short selling costs and causes uninformed short sellers to withdraw from the market. While we find a statistically and economically significant inverse relation between pre-announcement short activity and announcement period returns, when we control for the non-announcement ability of short sellers to predict future returns documented by Diether et al. (2009), the significance of the relation between pre-announcement short activity and announcement period returns vanishes. Thus, we infer that short sellers are not incrementally informed prior to earnings announcements.     

Do analysts who understand accounting conservatism exhibit better forecasting performance?

This study investigates the performance of analysts when they match the asymmetric timeliness of their earnings forecast revisions (i.e., asymmetric forecast timeliness) with the asymmetric timeliness of firms’ reported earnings (i.e., asymmetric earnings timeliness). We find that better timeliness‐matching analysts produce more accurate earnings forecasts and elicit stronger market reactions to their forecast revisions. Further, better timeliness‐matching analysts issue less biased earnings forecasts, more profitable stock recommendations and have more favorable career outcomes. Overall, our results indicate that analysts’ ability to incorporate conditional conservatism into their earnings forecasts is an important reflection of analyst expertise and professional success.     

Do investors affect financial analysts’ behavior? Evidence from short sellers

We examine how short sellers affect financial analysts’ forecast behavior using a natural experiment that relaxes short-sale constraints. We find that increased ease of short selling improves analyst earnings forecast quality by reducing forecast bias and increasing forecast accuracy. The improvements can be explained by both the disciplining pressure from short sellers and increased price efficiency from incorporating information in a timely manner. Although it is well documented that financial analysts can affect investors, our paper provides novel evidence on how sophisticated investors, short sellers, can affect analysts.     

Are short sellers positive feedback traders? Evidence from the global financial crisis

Short sellers are routinely blamed for destabilizing stock markets by exacerbating deviations from fundamental values. In response, regulators periodically impose short sale constraints aimed at preventing excessive stock market declines. One explanation is that policy makers regard short sellers as behaving like positive feedback traders. Relying on the theoretical model put forward by Sentana and Wadhwani (1992), which stresses the conditional nature of returns’ persistence, bans on selected financial stocks in six countries during the 2008/2009 global financial crisis are examined. These provide us with a setting to analyze the impact of short sale restrictions on feedback trading. Our findings suggest that, in the majority of markets examined, restrictions of this kind amplify positive feedback trading during periods of high volatility and, hence, contribute to stock market downturns. On balance then, short selling bans do not contribute to enhancing financial stability.     

Does accounting comparability affect corporate employment decision-making?

This paper investigates whether accounting comparability affects corporate employment decision-making. We find that firms with greater accounting comparability experience a lower degree of inefficiency in labour investments. Further, our results show that accounting comparability affects labour investments via improved external monitoring and internal governance mechanisms. Additional analyses indicate that our findings are not driven by non-labour investments and are robust to alternative explanations and endogeneity concerns. Collectively, the results are consistent with the view that comparability is an effective monitoring tool, which mitigates agency conflict and thereby reduces opportunistic employment decision-making.     

Is the decline in the value relevance of accounting driven by increased conservatism?

This paper examines the association between conservatism and the value relevance of accounting information over the 1975 through 2004 period. We measure conservatism using approaches developed in Penman and Zhang, The Accounting Review 77:237–264, (2002) and Beaver and Ryan, Journal of Accounting Research 38:127–148, (2000) and value relevance using (1) adjusted R ² from regressions of price on earnings and book values, (2) adjusted R ² from regressions of returns on earnings and changes in earnings, and (3) returns earned by perfect foresight of earnings and book values. We find no evidence that firms with increasing conservatism exhibit greater declines in value relevance. Rather, we observe most significant declines in value relevance for firms where conservatism has not increased. When we adjust financial statements for the effects of conservatism, we find that the value relevance of adjusted numbers is generally lower and trends in value relevance unaffected. Based on these results, it is implausible that increasing conservatism drives the decline in value relevance.     

CEOs’ experience of the Great Chinese Famine and accounting conservatism

This study investigates how a CEO's early-life experience of the Great Chinese Famine affects corporate accounting conservatism. We find that companies whose CEOs had experienced famines in early life adopted more conservative accounting policies. This famine experience effect is more pronounced in high uncertainty environments proxied by non-SOEs, politician turnovers and the adoption of International Financial Reporting Standards (IFRS). Additional tests indicate that CEOs with famine experience tend to support conservative accounting practices for contingencies and accelerate the recognition of asset impairments in negative events. Overall, consistent with imprinting theory, our results highlight the role of early-life traumatic experiences in shaping CEOs’ risk preferences and financial reporting policies.     

Capturing the straw in the wind: do short sellers trade on customer information?

Review of Quantitative Finance and Accounting - This study investigates whether short sellers trade the stocks of suppliers on customer information. Using the daily short-selling data derived from...     

Does short sales deregulation affect qualitative information disclosure?

We examine the impact of short sales deregulation on firms' disclosure of non-financial qualitative information. Our simple analytical model predicts that, after short sales deregulation and when the cost of disclosing proprietary qualitative information to the firm and its executives is sufficiently high, shortable firms respond by disclosing less proprietary and more non-proprietary qualitative information than non-shortable firms. Using a textual analysis of qualitative information about the supply chain, available in the management disclosure and analysis sections of the annual reports of a sample of Chinese firms, and applying a staggered difference-in-differences research design, we find evidence consistent with the model's prediction.     

Does short selling affect a firm's financial constraints?

Using a sample of Chinese A-share listed firms from 2007‐2017, we examine the impact of short sales on a firm's financial constraints. We develop three conceptual frameworks, the negative information effect, the undervaluation effect, and the deterrent effect, based on the prevailing theories and conduct an in-depth empirical analysis using the difference-in-differences, propensity score matching, and instrumental variable methods. Our findings suggest that: (1) Short sales generally worsen a firm's financial constraints by reducing its ability of raising cheap and overvalued external capital. (2) A shortable firm's financial constraints deteriorate more seriously in the case of higher credit risk or information asymmetry. (3) When a firm becomes shortable, its negative media coverage increases, external financing cost rises, and the amount of new external financing decreases. (4) The adverse impact of short sales on financial constraints is more pronounced for inefficient state-owned firms and mainly concentrates in the short term. Collectively, these results support the underlying logic of the negative information effect. However, further analysis shows that: (1) The deterrent effect also exists but is much weaker than the negative information effect. (2) The strength of the two effects will “wan and wax” with time or circumstances. Thus, the deterrent effect may outweigh the negative information effect by easing a firm's financial constraints in some cases, such as in the long term after short sales deregulation and when short sales magnitude is low or the managers are more sensitive to the decline of stock price. Our paper provides new insights into the impact of shorts sales on financial constraints, revealing some unique Chinese features compared to the US market and offering valuable lessons to other emerging markets.     

Does fair value accounting for non-financial assets pass the market test?

The choice between fair value and historical cost accounting is the subject of long-standing controversy among accounting academics and regulators. Nevertheless, the market-based evidence on this subject is limited. We study the choice of fair value versus historical cost accounting for non-financial assets in a setting where market forces rather than regulators determine the outcome. In general, we find a very limited use of fair value accounting. However, the observed variation is consistent with market forces determining the choice. Fair value accounting is used when reliable fair value estimates are available at a lower cost and when they convey information about operating performance. For example, with very few exceptions, firms’ managers commit to historical cost accounting for plant and equipment. Our findings contribute to the policy debate by documenting the market solution to one of the central questions in the accounting literature. Our findings indicate that, despite its conceptual merits, fair value is unlikely to become the primary valuation method for illiquid non-financial assets on a voluntary basis.