Conservative Accounting Choices

33 Pages Posted: 31 May 2002

Multiple version iconThere are 2 versions of this paper

Date Written: March 2004

Abstract

Managers have sufficient discretion under Generally Accepted Accounting Principles (GAAP) to adopt more or less conservative financial reporting policies. In this paper, we develop a signaling model to provide insight into managers' decisions to be conservative in their accounting. We provide conditions under which the market can use the manager's exercise of discretion to infer her private information about the future prospects of the firm and thus firm value. Under these conditions, we also show that there are meaningful differences between earnings response coefficients for firms whose managers choose a conservative reporting policy and those whose managers do not. Finally, we use our theoretical model to provide intuition for some established empirical results on earnings response coefficients.

Keywords: Conservative accounting, asymmetric information, signaling

JEL Classification: C72, D82, G12, M41

Suggested Citation

Bagnoli, Mark E. and Watts, Susan G., Conservative Accounting Choices (March 2004). Available at SSRN: https://ssrn.com/abstract=311432 or http://dx.doi.org/10.2139/ssrn.311432

Mark E. Bagnoli (Contact Author)

Purdue University ( email )

Department of Accounting
West Lafayette, IN 47907-1310
United States
765-494-4484 (Phone)
765-496-1778 (Fax)

Susan G. Watts

Purdue University ( email )

Department of Accounting
West Lafayette, IN 47907-1310
United States
765-494-4504 (Phone)
765-496-1778 (Fax)

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