Auditing Section Research Summaries Space

A Database of Auditing Research - Building Bridges with Practice

This is a public Custom Hive  public

research summary

    The Benefits of Conservative Accounting to Shareholders:...
    research summary posted September 17, 2015 by Jennifer M Mueller-Phillips, tagged 09.0 Auditor Judgment 
    The Benefits of Conservative Accounting to Shareholders: Evidence from the Financial Crisis.
    Practical Implications:

    This paper contributes to the literature in several ways. First, it furthers the understanding of the economic consequences of conservatism. Second, the paper is also related to the literature on the relation between the governance role of financial accounting information and economic performance. Finally, the results also have implications for regulators and accounting standard-setters. Some academic scholars argue that regulators and standard setters do not fully understand the reasons for and consequences of conservatism. The authors suggest that regulators and standard setters should fully consider the economic implications of conservatism before making regulation changes.


    Francis, B., I. Hasan, and W. Qiang. 2013. The Benefits of Conservative Accounting to Shareholders: Evidence from the Financial Crisis. Accounting Horizons 27 (2): 319-346.

    accounting conservatism, financial crisis, shareholder value
    Purpose of the Study:

    Positive accounting theory suggests that financial reporting conservatism is an efficient contracting and governance mechanism to mitigate information asymmetries and address agency problems, and it benefits users of the firm’s accounting reports. This study investigates whether conservative accounting affects shareholder value. Specifically, the authors use the recent financial crisis as a natural quasi-experiment to examine whether, and to what extent, conservative accounting affects firm performance in the equity market.

    The authors empirically examine the relation between conservatism and firm value changes during the crisis period defined to be from October 1, 2007 to March 31, 2009. The primary measure of conservatism is Khan and Watts’s (2009) C-score, which is based on Basu’s (1997) timeliness measure of conservatism. By incorporating firm-specific characteristics, such as size, market to book, and leverage into Basu’s model, the C-score captures both the time-series and the cross-sectional variations in measuring individual firms’ conditional conservatism. The authors measure firm value changes using the buy-and-hold abnormal returns during the crisis period.

    Design/Method/ Approach:

    The authors use a sample of 6,326 U.S. public companies, which they gathered using monthly stock data from the Center for Research in Security Prices (CRSP) and firm specific data from the Compustat database. The authors choose October 2007 as the beginning point and March 2009 as the ending point.


    The authors find a significantly positive relationship between accounting conservatism and buy-and-hold abnormal returns during the crisis period. Overall, the findings indicate that firms with a higher degree of conservative accounting prior to the crisis experience significantly smaller losses in the stock market compared to firms with a lower degree of conservative accounting. Furthermore, the authors find that the identified relation between conservatism and stock returns is conditional on governance or information environments of firms. Specifically, the authors find that the impact of conservatism on stock performance is more pronounced for firms with weaker corporate governance, higher bid-ask spreads, or lower analyst forecast accuracy, indicating that conservatism is more important for protecting shareholder value when firms have poorer corporate governance or have higher information risk.

    The authors find that, on average, more conservative firms enjoy lower cost of bank loans; reduce cash holding, capital expenditure, and R&D expenditure less; increase debt issuance more; and increase discretional accruals and default risk less compared to less conservative firms.

    Auditor Judgment