Conditional Conservatism and the Value Relevance of Accounting Earnings: An International Study

Abstract

Using a sample consisting of firms from 20 countries, we investigate whether conditional conservatism affects the value relevance of accounting earnings. We find that the association of conditional conservatism with the value relevance of accounting earnings depends on the country-specific level of accrual intensity. That is, in countries with higher accrual intensity, conditional conservatism is positively associated with the value relevance of earnings. We find that this effect is incremental to that of shareholder protection on the value relevance of accounting earnings documented in Hung (Journal of Accounting and Economics, 30, pp. 401–420, 2001). The results are consistent with conditional conservatism serving as an efficient contracting role to reduce managers' opportunistic behavior in the use of accruals. However, our results also indicate that the benefits of conditional conservatism are contextual and are lost in countries with lower accrual intensity.

Acknowledgements

The authors appreciate the generous research support of the Lubin School of Accounting at Syracuse University. The authors thank Maria Caban-Garcia, Scott Duellman, Erin Moore, Ray Pfeiffer, John Phillips, the Joint Guest Editor, Laurence van Lent, and two anonymous referees for helpful comments.

Notes

1. This study focuses on conditional conservatism and its association with the value relevance of accounting earnings. To the extent that unconditional conservatism affects the level of conditional conservatism (Beaver and Ryan, 2005; Gassen et al., 2006; Givoly et al., forthcoming; Roychowdhury and Watts, 2006; Ryan, 2006) and the value relevance of earnings, it is important that unconditional conservatism be controlled for. If unconditional conservatism does reduce the asymmetric timeliness of losses, as predicted by Beaver and Ryan (2005), then the presence of unconditional conservatism will make it harder for us to find any association between conditional conservatism and the value relevance of earnings. Because of these concerns, we present our main results both with and without an explicit control for unconditional conservatism.

2. See Barth et al. (2001) and Holthausen and Watts (2001) for summaries of value relevance research.

3. It is likely that the constructs of shareholder protection and conservatism are endogenously determined within the legal environments of the different countries. We leave the issues of endogeneity and causality for future research.

4. Hung (2001) has 21 countries. We drop one country from our sample, Ireland, due to a lack of data available to compute the alternative, non-returns, measure of conservatism proposed by Ball and Shivakumar (2005).

5. We thank the Editor for his guidance on this issue.