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Accounting conservatism and jump likelihood: is conservatism
desirable?
Masters thesis
Accountancy and Control
Amsterdam Business School
Faculty of Economics and Business, University of Amsterdam
2013 2014
Name: Lisette A. Lochtenbergh
Student number: 10000434
Supervisor: Dr. R.S. Boomsma
Date of final submission: June 23th 2014
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Abstract
The purpose of this research is to investigate to what extent the level of accounting
conservatism of a company influences the likelihood of a stock price jump of the company.
Prior research provided this study with a theoretical foundation on which this papers main
hypothesis is built (Jin and Myers, 2006; Hutton et al., 2009, Kim and Zhang, 2010; LaFond
and Watts, 2008). Following the previously mentioned underpinnings, this study expects that
conservatism would have a reducing effect on a companys jump likelihood. This paper
executes a logistic regression in order to examine whether there is a significant reducing
effect of the level of conservatism on a companys jump likelihood. The regression
demonstrates that the hypothesis can indeed be supported. The study of Kim and Zhang
(2010) found that accounting conservatism has a reducing effect on the crash likelihood of a
company. Combining both results, accounting conservatism on one hand seems to help
protect the company from possible costs associated with a stock price crash, but on the other
hand it also seems to contribute in depriving the company from possible benefits associated
with a stock price jump. Considering this, the desirability of accounting conservatism is not
that easy to assess. Bearing in mind, however, that markets demand more conservative
earnings as a means of mitigating agency costs (LaFond and Watts, 2008, p.476), this study
tends to conclude that the benefits of having fewer crashes should outweigh the costs of
having fewer jumps. This study, however, does advocate for further future research to
determine whether information asymmetry and thereby costs as a whole indeed decrease
because of accounting conservatism, because prominent accounting bodies like the FASB
(2008) continue to distance themselves from the principle of conservatism. This study
contributes to existing literature by filling a gap in a certain branch of conservatism literature,
which is a still somewhat new and emerging field of investigation. These papers all examined
accounting conservatism as a control mechanism used by principals. Furthermore, this paper
contributes to current conservatism debates by examining the desirability of accounting
conservatism in order for better-funded opinions.
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Samenvatting
Het doel van dit onderzoek is onderzoeken in hoeverre conservatief boekhouden een effect
heeft op de kans dat de aandelen van een organisatie een aandelenjump doormaken.
Voorgaand onderzoek biedt de theoretische basis waarop deze studie haar hypotheses heeft
ontwikkeld (Jin en Myers, 2006; Hutton e.a.., 2009, Kim en Zhang, 2010; LaFond en Watts,
2008). Gebaseerd op de voorgaand genoemde studies, verwacht deze studie dat conservatief
boekhouden een significant verkleinend effect heeft op de mogelijkheid van een
aandelenjump. Deze studie heeft dit onderzocht aan de hand van een logistische regressie. De
statische resultaten tonen aan dat de hypothese inderdaad is bewezen. De studie van Kim en
Zhang (2010) hebben aangetoond dat conservatisme een verkleinend effect heeft op de
mogelijkheid van een aandelencrash. Als deze resultaten worden gecombineerd kan men
afleiden dat conservatisme aan de ene kant een bedrijf probeert te beschermen tegen
mogelijke kosten van een aandelencrash, maar aan de andere kant een bedrijf ook mogelijke
baten van een aandelenjump lijkt te onthouden. Daaruit volgt dat het niet eenduidig vast te
stellen is of conservatief boekhouden wenselijk is of niet. Echter, uit de theorie van LaFond
en Watts (2008) volgt dat conservatisme een markt gevolg is. Er is vraag naar conservatisme
vanuit de markt, omdat conservatievere jaarverslagen leiden tot lagere informatie asymmetrie
en daarmee lagere agency kosten. Derhalve neigt deze studie te concluderen dat de baten van
lagere kosten door minder crashes zwaarder wegen dat de kosten van het mislopen van jump
baten, omdat conservatisme een markt effect is dat zal leiden tot minder agency kosten.
Desondanks pleit deze studie ervoor dat verder wordt onderzocht of de baten van minder
crashes inderdaad zwaarder wegen dan de kosten van minder jumps, omdat prominente
instituten zoals de FASB (2008) afstand blijven nemen van het principe van conservatisme.
Deze studie draagt op verschillende manieren bij aan voorgaand onderzoek. Allereerst, draagt
het bij door nog niet onderzocht gebied te onderzoeken binnen een opkomende tak binnen de
conservatisme literatuur. Deze studies hebben conservatisme allemaal onderzocht in een
breder of ander licht dan meer conventionelere theorien zoals de contracting theorie. Zij
zien conservatief boekhouden als een mechanisme dat door principalen wordt gebruikt om
het opportunistische gedrag van agenten te kunnen corrigeren. Daarnaast draagt deze studie
bij aan het hedendaags debat omtrent de wenselijkheid van conservatief boekhouden.
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Acknowledgements
I would like to thank Dr. R.S. Boomsma, my thesis supervisor, for his valuable and
constructive suggestions during the development of this thesis. Furthermore, I would like to
thank Dr. J.J.F. van Raak for his additional assistance.
I would also like to express my great appreciation for my mother, who supported and
encouraged me throughout my Masters thesis and my academic study as a whole.
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Table of contents 1. Introduction .......................................................................................................................... 6 2. Literature review and hypotheses development ................................................................ 9
2.1 Accounting conservatism .................................................................................................. 9 2.2 LaFond and Watts (2008) theory .................................................................................. 10 2.3 Prior literature and hypotheses development ................................................................ 11
3. Sample and research method ............................................................................................ 14 3.1 Sample ............................................................................................................................ 14
Table 1 .............................................................................................................................. 15 3.2 CSCORE model .............................................................................................................. 15 3.3 JUMP model ................................................................................................................... 16 3.4 Empirical model (H1a) ................................................................................................... 17 3.5 Portfolio analysis (H1b) ................................................................................................. 19
4. Descriptive statistics, results and interpretation ............................................................. 19 4.1 Descriptive statistics ...................................................................................................... 19
Table 2 .............................................................................................................................. 20 Table 3 .............................................................................................................................. 21
4.2 Results H1a .................................................................................................................... 21 Table 4 .............................................................................................................................. 22
4.3 Results H1b .................................................................................................................... 23 Table 5 .............................................................................................................................. 24
4.4 Interpretation of results .................................................................................................. 25 5. Conclusion ........................................................................................................................... 28 References ............................................................................................................................... 31 Appendix A ............................................................................................................................. 33
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1. Introduction
Above average stock increases and decreases, hereafter jumps and crashes, are often
the result of the disclosure of dramatic good or bad news to the market. With regard to the
likelihood of a crash, research found that opaque financial statements significantly increase
this likelihood (Hutton et al., 2009). Opaque financial statements are generally the result of
earnings management, which encompasses the withholding of certain bad news and
disclosing good news as soon as possible, because managers hope that current bad news will
be outbalanced by future good news. Managers manipulate earnings, because of (often short
term horizon) opportunistic reasons like bonuses or career interests (Ball, 2009; Graham et al.,
2005; Kothari et al., 2009). The bad news hoarding, however, cannot persist forever, as over
time it becomes too costly or just practically impossible. Consequently, at a certain point in
time the bad news hoarding reaches a tipping point resulting in a revelation of a great amount
of bad news. This can potentially result in a stock price crash.
Hutton et al. (2009) found that financial statement opacity, caused by managers
incentives for bad news hoarding, increases the likelihood of a stock price crash. The authors
additionally examined this relation with regard to the likelihood of market jumps, but opacity
has no effect on he likelihood of a stock price jump. This was as expected on beforehand,
because managers are not likely to not have incentives to withhold good news. Accounting
conservatism is a concept that can be seen as a correcting mechanism against the incentives of
managers to withhold bad news, because conservatism encourages the exact opposite:
disclose bad news more rapidly and set higher requirements for recognizing good news. In
this light, previous research wanted to examine if accounting conservatism decreases the
likelihood of a stock price crash. Kim and Zhang (2010) indeed found evidence to support
this hypothesis.
Following Kim and Zhang (2010) and Hutton et al. (2009), this study examines the
possible effect that accounting conservatism could have on the likelihood of a stock price
jump. As stated before, accounting conservatism works as a mitigating mechanism for bad
news hoarding of managers. Generally, a manager is not likely to have incentives to withhold
good news (Hutton et al., 2009). Accounting conservatism, however, works in both ways and
also influences how managers have to deal with good news. A manager working in a more
conservative company, is expected to recognize good news less easily as such as a manager at
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a less conservative company. Consequently, the release of a great amount of good news that
could lead to a stock price jump is expected to occur less likely. Therefore, this research
expects, other things equal, that accounting conservatism decreases the likelihood of future
stock price jumps.
There are two types of accounting conservatism: unconditional accounting
conservatism and conditional accounting conservatism. Unconditional accounting
conservatism is news independent conservatism, which means that it is a system where
expenses are systematically accelerated and revenues systematically deferred. Conditional
conservatism is news dependent, which means that it asymmetrically reflects bad news over
good news. Hence it reflects bad news on a timelier basis than good news, but it does not
systematically result in a lower profit as with unconditional conservatism. When this study
refers to accounting conservatism, it refers to the conditional form of accounting conservatism
(Li, 2010; Kim and Zhang, 2010).
This paper contributes to existing literature in several ways. Above all, it fills a gap in
a certain branch of conservatism literature by proceeding on papers like Jin and Myers (2006),
Hutton et al. (2009), Kim and Zhang (2010) and LaFond and Watts (2008). The papers by Jin
and Myers (2006), Hutton et al. (2009) and Kim and Zhang (2010) built their hypotheses on
the notion that accounting conservatism acts as a contra mechanism for the opportunistic
behaviors of managers. Additionally, LaFond and Watts (2008) found evidence for a reason,
other than conventional ones like contracting, as to why accounting conservatism exists in
line with the papers of Jin and Myers (2006), Hutton et al. (2009) and Kim and Zhang (2010).
They found evidence for an actual market demand for accounting conservatism in line with
the notion of principals wanting to correct for their managers opportunistic behaviors. This
branch of conservatism literature is still a somewhat new and emerging field of investigation
to which this study contributes. In particular, this study extends the study of Kim and Zhang
(2010) by (i) again building on the previously described theory and by (ii) additionally
examining the possible effect of accounting conservatism on the likelihood of a stock price
jump next to its effect on the likelihood of a stock price crash. The results of this study
complement the result of Kim and Zhang (2010) by showing that accounting conservatism,
next to reducing the crash likelihood, also reduces the jump likelihood. Thereby, this study
demonstrates that the desirability of accounting conservatism is not that easily assessed when
considering both effects.
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As stated earlier, this study contributes to prior literaure in multiple ways. First, it
contributes to current debates with regard to the desirability of accounting conservatism. In
2008, one of the leading accounting institutes, the FASB, declared that it no longer planned
to incorporate accounting conservatism as a desirable feature in its accounting principles
because they found that it increases information asymmetry. They stated that the Boards
concluded that describing prudence or conservatism as a qualitative characteristic or a
desirable response to uncertainty would conflict with the quality of neutrality (FASB, 2008,
p. 28). According to the FASB, accounting conservatism interferes with neutrality, because
the higher verification requirements for gains relative to losses allow a form of bias in the
information of financial statement. This bias leads to information asymmetry between the
company outsiders and company insiders, and this is seen as inconsistent with neutrality.
With this statement, the FASB implies that accounting conservatism will be likely to
undermine the quality of neutrality as the most important quality in order to provide the
attainment of highest decision usefulness for investors.
However, academic literature (LaFond and Watts, 2008; LaFond and Roychowdhury,
2008) found evidence for an intrinsic market demand for conservatism, which suggests that
conservatism actually contributes to decision usefulness of decision making of investors.
Moreover LaFond and Watts (2008) found that their findings are more robust than the
statements of the FASB. Therefore, according to LaFond and Watts (2008), if the FASB
would succeed in minimizing conservatism, information asymmetry would actually increase
instead of decrease. Despite these significant findings, with possibly great implications with
regard to the recent movement of the FASB, the FASB and other accounting bodies continue
to distance themselves from the concept of accounting conservatism and are increasingly
moving towards the notion of fair value accounting. An important shift in a principle like this
should be informed by extensive, in-depth and critical academic research like LaFond and
Watss (2008). As stated before, this papers first contribution would be to contribute to
current conservatism debates by examining the desirability of accounting conservatism in
order for better-funded opinions. Inherently, this researchs second contribution is to provide
new insights in the effect of accounting conservatism as a correcting mechanism of the
optimism bias and whether conservatism increases or decreases information asymmetry.
Third, it thereby contributes by discovering either a new advantage or a new disadvantage of
accounting conservatism. Fourth, this is of importance for regulatory, accounting and
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economic bodies, because it improves their ability to better weight the advantages and
disadvantages of incorporating accounting conservatism in regulations.
Fifth, although accounting conservatism is one of the main research areas of
accounting, current literature focuses its attention mainly on one aspect, i.e. explaining why
conservatism exists (Watts, 2003b; Ball et al., 2000; Bushman and Potarski, 2006, LaFond
and Watts, 2008). The positive and negative consequences of conservatism are however
examined to a lesser extent. Some exceptions are Ahmed et al. (2002), Wittenberg-Moerman
(2008), Zhang (2008) and Kim and Zhang (2010). This study would like to contribute to this
relatively smaller sub area.
This remainder of this thesis is structured as follows. Chapter 2 reviews the key
literature on the topic of accounting conservatism and hereby outlines (i) the more addressed
conventional argumentation behind the reasons of its existence and (ii) a new, emerging
theory about the reasons for conservatism. Chapter 2 also reviews some particular studies of
interest in order for this study to develop its main hypothesis. In addition a second hypothesis
is developed in order to give this study more depth by considering alternative interpretations.
Chapter 3 outlines the sample selection process and research method. Chapter 4 describes the
descriptive statistics and presents the statistics. In addition, chapter 4 present a discussion that
further interprets the results by making use of the papers and theories introduced in chapter 2.
Chapter 5 presents the conclusion.
2. Literature review and hypotheses development
2.1 Accounting conservatism
Conservatism in accounting is a subject within the major accounting research areas of
the present-day (Scott, 2012). In 1997, Basu (1997) was the first to empirically examine
accounting conservatism in financial reporting; his results mainly confirmed its existence. He
used an earnings-relation model in order to assess the existence of conservatism. Basu found
that bad news was reflected earlier in financial reporting than good news. Watts (2003a;
2003b) addressed the subject in two other seminal papers on accounting conservatism. Part
1: Explanations and implications developed a definition of accounting conservatism and, as
the title implies, provided several explanation for conservatism (including contracting). With
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respect to its content, Watts (2003a) definition is similar to that of Basu (1997). Watts
(2003a, p. 208) expresses accounting conservatism as the asymmetrical verification
requirement for gains and losses. Barth et al., (2013, p. 1) defines conservatism as a larger
response coefficient for negative return than for positive return in an earnings-return
regression. Furthermore, the FASB (2008, p. 28) refers to conservatism, or as they propose
prudence, as that possible errors in measurement be in the direction of understatement
rather than overstatement of net income and net assets. In other words, accounting
conservatism encompasses that the mandatory requirements in order to recognize profits are
higher than the requirements for recognizing losses, and thus indicates a more
reserved/conservative practice of accounting.
With regard to the different explanations for accounting conservatism, Watts (2003a)
distinguishes four explanations of accounting conservatism, i.e. contracting, litigation,
taxation and regulator. The two most addressed explanations in existing literature are
contracting and litigation (Watts, 2003a). According to Watts (2003a), there are three types of
accounting conservatism under the contracting explanation: conservatism and debt contracts;
conservatism and executive compensation contracts; conservatism and firm governance. The
contracting explanation states that accounting conservatism exists, because of moral hazard
problems caused by asymmetric pay-offs, asymmetric information, limited horizons and
limited liabilities. A firm can protect itself from these problems by means of accounting
conservatism. To illustrate, an example of the first type accounting conservatism and debt
contract under the contracting explanation is provided. If a firm and a debt holder agree into
a debt contract, the debt covenant, the debt holder is likely to include certain clauses that
decrease the likelihood that a firm acts at the expense of the interest of the debt holder. For
example, the debt covenant could prevent paying out liquidating dividends to shareholders or
other clauses that discourage any behavior that may damage the firms ability to repay the
loan. The litigation explanation states that, because the litigation costs of overstatements are
considerably higher than the costs of understatements, firms tend to safeguard it by means of
accounting conservatism (Watts, 2003a; Scott, 2012).
2.2 LaFond and Watts (2008) theory
A recent study on accounting conservatism by LaFond and Watts (2008) sheds another
light on the reason why conservatism exists. Their finding is an extension of the already
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existing contracting theory, because it states that conservatism not only exists in order to
reduce agency costs caused by debt contracts, compensation contracts and firm governance,
but to reduce agency costs as a whole. LaFond and Watts (2008) finding, consequently, is
related to the well-known agency theory.
LaFond and Watts (2008) found evidence in favor of an intrinsic demand for
conservatism from investors themselves. This intrinsic demand stems from the fact that
conservatism mitigates the so-called optimism bias. The optimism bias leads to information
asymmetry. This information asymmetry is caused by incentives of managers to overstate the
financial statements, because of for example opportunistic behavior. This information
asymmetry between the investor, principal, and the managers, agents, creates agency costs
(e.g. over- or under investments). This is where accounting conservatism comes into play.
When managers overstate assets or understate liabilities, accounting conservatism functions
as a contra mechanism to adjust this downwards and thereby reduce information asymmetry
and agency costs. So, investors demand more conservative earnings as a means of mitigating
agency costs (LaFond and Watts, 2008, p.476). In other words, LaFond and Watts (2008)
findings show that accounting conservatism is more than a means to reduce contracting costs,
but that it is actually a market result caused by information asymmetry between the agent and
the principal. LaFond and Roychowdhury (2008) also found evidence in line with a market
demand for accounting conservatism. They find that the higher the separation of ownership
and control, the higher the agency problems, and the higher the demand for conservatism as a
mechanism to deal with these agency problems. This theoretical notion as to why
conservatism exists will be used later in this study as a means to interpret the results from the
hypotheses.
2.3 Prior literature and hypotheses development
As stated earlier, this study would like to contribute to the sub area of the
conservatism literature that examines the possible consequences of accounting conservatism.
Prior literature of this area found both advantages and disadvantages with regard to
conservatism. For example Barth et al. (2013) found that conditional conservatism is
significantly negatively related to a lower information content of earnings. They found that
conservatism results in (i) a delayed resolution of investor disagreement after an earnings
announcement and (ii) higher economic costs caused by higher equity costs and higher
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dispersion of analysts forecasts after an earnings announcement. However, Li (2010) find
that countries with relatively more conservatism companies have lower cost of debt and
equity. Biddle et al. (2011a) found that both conditional and unconditional accounting
conservatism mitigates bankruptcy risk, because of the informational role it plays in these
types of critical situations. Conservatism can help in reducing debt costs and enhance
liquidity, because investors and lenders are more willing to cooperate with the company. They
trust the company relatively more, because conservatism reduces overvaluing/hiding
behavior. Furthermore, Biddle et al. (2011b) found that both conditional and unconditional
conservatism lead to lower operating cash flow downside risk, meaning a lower difference
between the actual return and the expected return.
The studies of Hutton et al. (2009) and Kim and Zhang (2010) are particularly
important for this research, because the theory used in order to develop their hypotheses is
also used in this study. Hutton et al. (2009) examined the association between the opacity of
financial statements, proxied by earnings management, and the likelihood of a stock price
crash. They examined this by building on the following theoretical link. Managers of a
company have incentives to manage earnings, because of for example opportunistic reasons.
However, managing bad news is only possible until a certain tipping point is crossed, because
it becomes for example too costly. Ones this point is crossed all the accumulated bad news
will come out all at once resulting in a dramatic revelation of bad news, which could result in
a stock price crash. Hutton et al. (2009) indeed found supportive evidence for this theory and
found that opaque financial statements increase the likelihood of a stock price crash. The
authors also examined the effect of opacity on the likelihood of price jumps, but found no
effect. They predicted this on beforehand, because managers should have no incentives to
manage/hide good news. In the same line of thinking, Kim and Zhang (2010) examined the
effect of accounting conservatism on the likelihood of a stock price crash. Accounting
conservatism reduces the incentives of managers to hide bad news, because of the
asymmetrical verification requirement for good news relative to bad news. Therefore, Kim
and Zhang (2010) predicted that the tipping point that releases accumulated bad news is
achieved less likely for companies that use conservative accounting practices, resulting in a
lower likelihood of a stock price crash. The authors indeed found evidence for this, signifying
that conservatism reduces the likelihood of a stock price crash. However, Kim and Zhang
(2010) did not examine the effect of accounting conservatism on the likelihood of a stock
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price jump. Therefore, this research wants to contribute by addressing this gap in existing
literature.
Hutton et al. (2009) demonstrated that opaque financial statements increase the
likelihood of a stock price crash, and the study of Kim and Zhang (2010) demonstrated that
accounting conservatism on the contrary decreases this likelihood because it works as a
stimulant to recognize bad news sooner. The research of Hutton et al. (2009) also showed that
opaque financial statements have no effect on the likelihood of a stock price jump.
Accounting conservatism can however have an effect on the likelihood of a stock price jump.
Just like bad news is disclosed relatively sooner by conservative companies, good news is
recognized less rapidly, because they set higher requirements. Consequently, a point where a
great amount of good news is released in an instant, leading to a stock price jump, will occur
not so readily with conservative companies as with less conservative companies. Building on
the previously explained theoretical link, this research hypothesizes the following:
H1a: Accounting conservatism in financial statements reduces the likelihood of a
future stock price jump, ceteris paribus.
It is possible, to reason even further. Accounting conservatism could possibly work as
a mechanism that not only reduces bad news hoarding (Kim and Zhang, 2010), but also
increases good news hoarding. Accounting conservatism can slow down the recognition of
good news to such an extent that it actually increases the likelihood of a stock price jump.
Conservatism could even incentivize the hiding of good news until a certain tipping point is
achieved where it is no longer possible to hide the good news, resulting in a stock price jump.
On beforehand of the tests, however, this study deems this to be unlikely, because
conservatism can not be seen as the exact opposite of earnings management. Managers of
conservative companies do not actually withhold good news, they only set higher
requirements before recognizing it as such (Hutton et al., 2009).
Another finding that could challenge hypothesis 1a is of Kim and Pevzner (2010).
They found that the stock market reacts stronger (weaker) to good (bad) news of more
conservative companies relative to less conservative companies. This would imply that
conservatism would not have a reducing effect on the likelihood of a stock price jump,
because the smaller amount of good news that is disclosed by conservative companies weighs
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relatively more, which would balance out the effect. This study does not expect this to be of
general significance, because (i) Kim and Zhang (2010) already demonstrated the reducing
effect of conservatism on the likelihood of a stock price crash and (ii) Kim and Pevzner
(2010) found somewhat weak evidence for this result. However, it is imaginable that the
results of hypothesis 1a differs for high-conservative companies compared to medium- or
low-conservative companies, because the stock markets are then generally aware of their
accounting conservatism given its high level. Hence, in order to give this study more depth by
considering another interpretation, it will additionally conduct a portfolio analysis that takes
the study of Kim and Pevzner (2010) into account. It will examine whether the results of
hypothesis 1a (significantly) differ for relatively high-conservative companies. Therefore, this
study would like to examine the following hypothesis:
H1b: The possible reducing effect of accounting conservatism in financial statements
on the likelihood of a future stock price jump is neutralized for high-conservative companies,
ceteris paribus.
3. Sample and research method
3.1 Sample
The sample of this study consists of data on all U.S. companies included in the north-
American databases Compustat and the Center for Research in Security Prices. A description
of all the variables can be found in Appendix A. The sample comprises the last ten years,
from January 2004 to December 2013. Initially, this studys intention was to comprise the
years 1962-2013, but because of (i) the time scope of this masters thesis and (ii) practical
limitations the sample needed to be scaled down. During this study a sample year is expressed
as a firms fiscal year.
After gathering all the needed data, certain selection criteria need to be met. First of
all, observations with missing data were dismissed. Second, following Khan and Watts
(2009), total assets and book value of equity needed to exceed $0,00 and the closing fiscal
year share price needed to exceed $1,00. Third, also in line with Khan and Watts (2009),
companies were dismissed if they fell in the top or bottom percentiles of earnings, annual
returns, market value of equity, market-to-book ratio or leverage. The final sample consisted
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of 9741 company years. Table 1 presents the number of observations, i.e. company years, for
each fiscal year. It is notable that the number of observations of 2012 and 2013 is relatively
less. This may stem from the fact that not all information is gathered yet for these last two
years, but this study did not find explicit confirmation for this.
Table 1
Number of observations, i.e. company years, per fiscal year Fiscal year N %
2003 1244 12,77
2004 1188 12,20
2005 1139 11,69
2006 1072 11,01
2007 1004 10,31
2008 892 9,16
2009 871 8,94
2010 841 8,63
2011 807 8,28
2012 362 3,72
2013 321 3,30
Total 9741 100
3.2 CSCORE model
This study uses the CSCORE model of Khan and Watts (2009) in order to measure the
level of accounting conservatism of a company. The model of Khan and Watts (2009) is
preferred over other conservatism models, because it (i) fits with the purpose of the
hypotheses and (ii) represent a more sophisticated version of the widely used Basu (1997)
model. It fits with the hypotheses), because it measures the conditional form of conservatism
conservatism and because it measures conservatism on the firm-level. Moreover, selecting
this model is in line with the related paper of Kim and Zhang (2010).
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As stated before, the CSCORE measure is based on the Basu (1997) model. The Basu
model measures the extent of good news recognition relative to bad news recognition per
company:
Xjt = 1t + 2tDjt + 3jtRjt + 4jtDjt * Rjt + jt (1)
X refers to the earnings before extraordinary items divided by the market value of equity. j
represent the company and t the (fiscal) year. R is the yearly market return compounded from
monthly returns, D is a dummy variable that equals one if R is beneath 0, and zero otherwise,
and is the residual. The coefficient 3 measures the timeliness of good news recognition, 4
measures the level of conservatism (the timeliness of bad news recognition over good news
recognition) and 3 + 4 together measure the timeliness of bad news recognition.
Khan and Watts enhanced the Basu (1997) model by replacing the coefficients 3 and
4 by functions that represent specific features that are consistent with the timeliness of good
news recognition (3) and with the level of conservatism (4), respectively:
GSCORE = 3jt = 1t + 2tMKVjt + 3tMBjt + 4tLEVjt (2)
CSCORE = 4jt = 1t + 2tMKVjt + 3tMBjt + 4tLEVjt (3)
In these functions MKV equals the natural log of the market value, MB is the market-to-book ratio, and LEV is the debt-to-equity ratio. By inserting the new functions in the former Basu (1997) model, the final empirical model can be written down as follows:
Xjt = 1t + 2tDjt + Rjt (1t + 2tMKVjt + 3tMBjt + 4tLEVjt)
+ Djt * Rjt (1t + 2tMKVjt + 3tMBjt + 4tLEVjt) +(1tMKV
+ 2tMB + 3tLEV + 4tDjtMKV + 5tDjtMB + 6tDjtLEV) + jt (4)
In order to measure the empirical model (function 4), five-year rolling panel regressions are
employed. Then the resulting coefficients 1, 2, 3 and 4 are applied to the third function in
order to compute the eventual CSCORE.
3.3 JUMP model
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This study uses a model developed by Jin and Myers (2006) in order to measure the
jump likelihood of a stock. The model of Jin and Myers (2006) is chosen, because it again fits
the hypotheses of this study very well. The model of Jin and Myers (2006) is able to measure
the likelihood of a jump in stock prices per company per (fiscal) year, which suits the purpose
of this study. Furthermore, related papers like Hutton et al. (2009) and Kim and Zhang (2010)
also employed this jump likelihood model.
The empirical models basis is the expanded market model regression, which
measures the relation between a specific stock return compared to the value-weighted market
index return:
rj,t = j + 1jrm,t-2 + 2jrm,t-1 + 3jrm,t + 4jrm,t+1 + 5jrm,t+2 + jt (5)
rj,t represents the stock return of stock j in week t and rm,t is the market index return in week t.
After that the natural logarithm of the residual pus 1 is taken in function 6, which results in
the eventual firm-specific weekly return (W):
Wj,t = ln(1+ j,t) (6)
In order to measure the jump likelihood per company per fiscal year, the binary indicator
JUMP is introduced. JUMP equals one if a company encounters more than one jump week
per (fiscal) year, and zero otherwise. The firm-specific weekly return is denoted as a jump
week if it is 3,2 standards deviations above the mean of the firm-specific weekly returns for
the given fiscal year.
3.4 Empirical model (H1a)
Following Kim and Zhang (2010), this study employs the following empirical model
in order to estimate the possible reducing effect of accounting conservatism (CSCORE) in
year t on the jump likelihood (JUMP) in year t+1:
m
JUMPt+1 = 0 + 1CSCOREt + + q (qthControlVariablest) + t (7) q=2
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The empirical model represents a logistic model. JUMPt+1 is a binary indicator that equals one
if a company encounters more than one jump week in year t+1, and zero otherwise. 1 is
expected to be below zero, which indicates the expected reducing effect of CSCORE on
JUMP (negative relation).
To control for external factors known to influence jump likelihood, the following
control variables are included in the logistic regression: SIZE and DTURN. First, firm size is
included as a control variable in order to control for the size effect (Hutton et al., 2009; Kim
and Zhang, 2010). Firm size is proxied by the natural logarithm of sales instead of the natural
logarithm of market value, because of possible multicollinearity problems. Hence, market
value is one of the important variables in order to compute the CSCORE measure. Second,
DTURN is included, because it controls for investor heterogeneity. The variable definitions of
the control variables can all be found in Appendix A.
In a latter regression, MB, LEV and ROE are also incorporated as control variables.
This is not done, however, in the primary regression. MB and LEV are important components
of computing the CSCORE. Consequently, incorporating them in the primary logistic
regression could result in minor results because of multicollinearity. Following Hutton et al.
(2009), contemporaneous ROE is also included in the latter regression as a control variable in
order to mitigate the possible effects of a companys profitability on its jump likelihood. ROE
is proxied by income before extraordinary items divided by the book value of equity.
Therefore, ROE is only used in the latter regression for the same reasons of multicollinearity,
because the book value of equity is also used in order to compute the MB variable. Initially,
this study wanted to incorporate the control variables SIGMA, RET and NCSKEW as well,
because this would have been in line with related papers (Kim and Zhang, 2010; Hutton et al.,
2009; Chen et al., 2001). These variables would not have been incorporated in the main
logistic regression, but in the latter regression as well. The three control variables are based
on the variable W, which is also the basis for the JUMP variable. Therefore, these three
control variables would again not have been incorporated in the initial logistic regression
because of multicollinearity problems. SIGMA controls for weekly return volatility; RET
controls for past one-year average weekly returns; NCSKEW controls for negative skewness.
However, taking into account the possible multicollinearity problems and given the time
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scope of this research and other practical limitations like the needed skills and experience
with statistical software, this study chose to let these measures alone for this study.
3.5 Portfolio analysis (H1b)
In order to examine whether the jump likelihood differs for high-conservative
companies relative to medium- or low-conservative companies, this study compares the
logistic results (H1a) of companies with low to high levels of accounting conservatism. In
order to conduct this portfolio analysis, the sample is first split into three percentile groups
(from low=1 to high=3) based on their level of conservatism (=CSCORE). Second the
likelihood results associated with each group are calculated using equation 7 and then
compared.
4. Descriptive statistics, results and interpretation
4.1 Descriptive statistics
Table 2 presents the descriptive statistic of the main variables. These variables are
used in the final empirical model, i.e. equation 7. They include the dependent variable
JUMP(t+1), the independent variable of key interest CSCORE and the control variables. The
mean of JUMP(t+1) of 0,6095637 indicates that 60,96% of the companies experienced one or
more jump weeks per fiscal year. This is above the average of jump weeks that can be found
in relating papers, i.e. 25-35% (Hutton et al., 2009; Chung, 2013; Wang, 2012). However, to
the knowledge of this paper, this paper followed the same practice to come to this. The
standard deviation also seems quite high. Therefore, this study believes that the smaller
sample size or possibly outliers cause the relatively higher mean and standard deviation.
Additionally, calculating the jump likelihood based on this exact methodology has not been
don extensively, which could mean that the actual averaged mean might indeed lie higher
than 25-35%. Finally, this study based its jump likelihood on the mean plus 3,2 times the
standard deviation, whilst for example Hutton et al. (2009) maintained a standard deviation of
3,09. The CSCORE mean and median are a smaller than the means found in related papers
like Kim and Zhang (2010) or Khan and Watts. However, this is possibly due to again a
smaller sample size. Moreover, this study had to deal with a small amount of multicollinearity
during the calculation of CSCORE. Given the time scope and knowledge limitations of this
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study, this study chose to not correct for this multicollinearity. Moreover, the correlations
between the CSCORE measure and other variables are generally very well in line with
relating papers (see table 3). Lastly, the other descriptive statistics are all very well in line
with relating papers. The means, medians and standard deviations of all the control variables
seem to be constructed accordingly.
Table 2
Descriptive statistics
Variable Mean Std. Q1 Median Q3 N
JUMP(t+1) 0,6095637 0,4878773 0 1 1 8365
CSCORE 0,0196971 0,0188821 0,0064443 0,0190496 0,0326033 8195
SIZE 6,775931 2,285423 5,343659 6,890083 8,415277 8133
DTURN 0,0062065 0,1604104 -0,0181034 0,0030604 0,0314372 6505
ROE 0,0617019 0,5461075 0,0331303 0,1012792 0,1695068 8195
MB 2,886754 3,578136 1,343489 2,022222 3,171888 8195
LEV 0,1129471 0,387583 0,0003819 0,0144073 0,0649292 8195
Appendix A provides a complete overview of all the variables and their definitions.
Table 3 presents the correlation matrix of the key variables. The correlations are all in
line with related papers like Kim and Zhang (2010), Hutton et al. (2009), Chung, 2013 and
Wang, 2012, which supports the reliability of this study. The one noticeable difference lies in
the correlation between (i) SIZE and CSCORE. This is an evident negative correlation, which
is in line with Kim and Zhang. However, -80,15% lies above the correlation found by for Kim
and Zhang (2010) of -40%. The exact reason behind this difference is not exactly clear, but it
could be possibly due to the multicollinearity factor in the CSCORE measure or again the
relatively smaller sample size.
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Table 3
Correlation matrix
Variable JUMP(t+1) CSCORE DTURN ROE SIZE MB LEV
JUMP(t+1) 1.0000
CSCORE 0.0553 1.0000
DTURN -0.0050 -0.0321 1.0000
ROE -0.0250 -0.1354 0.0025 1.0000
SIZE -0.0878 -0.8015 0.0478 0.1304 1.0000
MB -0.0011 -0.3601 0.0015 -0.0023 -0.0398 1.0000
LEV -0.0374 0.1047 0.0459 -0.0475 0.0817 -0.1047 1.0000
Appendix A provides a complete overview of all the variables and their definitions.
All in all the descriptive statistics and correlations between the key variables seem to
be constructed well and seem to be in line with the related papers. The most noticeable
difference lies mainly in the mean and median of the jump likelihood, but (i) because of the
previously mentioned reasons and limitations like for example the smaller sample size and (ii)
because of the fitting correlations this is let alone for this thesis.
4.2 Results H1a
Table 4 presents the logistic regression, i.e. equation 7, which predicts the jump
likelihood. All the coefficients of the variable of key interest her, the CSCORE, are negative.
This is in line with the main hypothesis that accounting conservatism has a reducing effect on
the likelihood of a jump event. In the first model, model a, a plain logistic regression is
executed in which only the size effect is controlled for. The coefficient of CSCORE is indeed
negative, but not yet significant. The P-value here equals 11,5%, which already provides
some evidence for a reducing effect, but its not clearly significant. In model b, the control
variable DTURN is added. This does affect the coefficient of CSCORE to become significant,
but the P-value of DTURN is highly insignificant. In model c, ROE, MB and LEV are added
as control variables. As explained in chapter 3, these variables are expected to cause
multicollinearity effects. The P-values range from 5-20%, which means that they seem to
improve the model, but not significantly. This study expects this to be due to the
multicollinearity effects. Additionally, the coefficient of CSCORE becomes very significant.
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22
Finally, model d is constructed, which includes all the control variables of model c except for
the highly insignificant DTURN variable. This model provides the most significant
coefficient of CSORE and the other variables (and constant) are also of significant or strong
influence. Taking into account that the relatively higher P-values of ROE and LEV could be
due to multicollinearity, model d provides this study with the best results for further
interpretation.
As stated before, the coefficients of CSCORE in all four models are negative. This
indicated a reducing effect of accounting conservatism on the jump likelihood, which is in
line with hypothesis 1a. When looking at model d in particular, the coefficient of CSORE
equals 1,1%. This indicates a high significant reducing effect of accounting conservatism on
the jump likelihood. Therefore, this study found significant evidence for the main hypothesis,
hypothesis 1a.
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Table 4
Predicting the jump likelihood: logistic regression of JUMP(t+1) on CSCORE(t)
*** p
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4.3 Results H1b
Table 5 presents the portfolio analysis, which is executed in order to examine
hypothesis 1b. This portfolio analysis is based on model d, because this study perceives
model d to fit further examination best (see section 4.2). For the portfolio analysis, this study
distinguishes three groups based on their conservatism scores, i.e. low-, medium- and high
conservative. When looking at the coefficient of CSORE for all three groups, it seems that a
downward trend may be found. For group 1, the coefficient of CSCORE equals 4,95,
indicating a positive effect. For group 2, the coefficient of CSCORE decreased relative to its
coefficient of group 1. It equals 0,81, which seems to go in the direction of zero indicating a
somewhat neutral effect. For group 3, the high conservative group, the coefficient continues
to decrease even further to -22,95. This trend is in line with hypothesis 1a that the level of
conservatism has a reducing effect on the jump likelihood. However, given the high
insignificant coefficients of group 1 and 2, a real trend cannot be affirmed. The declining
coefficients are, however, noticeable when taking into account the overall result of hypothesis
1a. Especially given the fact that the coefficient of the CSCORE measure of group 3 is both
very negative and highly significant.
Turning to hypothesis 1b, however, it seems that the portfolio analysis does not
support this hypothesis. The expected result of hypothesis 1b would be a significant or at least
stronger negative coefficient of CSCORE for group 2 and a more neutralized coefficient of
CSCORE for group 3. This was based on the finding of Kim and Pevzner (2010) that
investors react stronger (weaker) to good (bad) news of more conservative companies relative
to less conservative companies. When looking at table 5, this appears not to be the case.
Therefore, this study found no evidence in favor of a neutralized effect of conservatism on the
jump likelihood and hypothesis 1b is rejected. The coefficients only seem to move in line
with hypothesis 1a.
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Table 5
Portfolio analysis of three conservatism groups, i.e. low-, medium- and high conservative.
*** p
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4.4 Interpretation of results
The aim of this section is to further interpret the statistical results by means of the
theoretical underpinnings of the hypotheses. As concluded from the statistical tests, this study
found significant evidence that supports the main hypothesis that accounting conservatism in
year t has a reducing effect on the jump likelihood in year t+1. The evidence for this result is
a negative, significant coefficient of the CSCORE measure in the logistic regression on
JUMP(t+1), see table 4. Hypothesis 1b is rejected, because the evidence of the portfolio
analysis only seems to further support the main hypothesis. A neutralized effect has not been
found for the high-conservative group, see table 5.
The theoretical underpinnings of the main hypothesis of this study flow from a
theoretical link first developed by Jin and Myers (2006). Managers have incentives to release
as much as good news as possible to the investors on the market. By releasing good news (or
not releasing bad news) a manager may for example receive bigger bonuses because of the
positive reactions of investors on the market to the good news. Hence, the manager starts to
hoard bad news as much as possible. However, this bad news hoarding can only go on until a
particular tipping point is crossed, because the hoarding becomes too costly for example.
Subsequently, all the hidden bad news is released to the market all at once, which could result
in a stock price crash. Accounting conservatism reduces these incentives of managers to hide
bad news, because of the stronger verification requirements for good news relative to bad
news. Subsequently accounting conservatism could work as a mechanism to control for these
incentives of managers, because the accounting mechanism incentives the relative sooner
release of bad news. Therefore, Kim and Zhang (2010) predicted that accounting
conservatism has a reducing effect on the crash likelihood of a company. Kim and Zhang
(2010) indeed found evidence for this. This study extended the study of Kim and Zhang
(2010) by applying the same line of thinking on the likelihood of a stock jump. Conservative
companies disclose bad news relatively sooner and good news is recognized less rapidly,
because they set higher requirements. Consequently, a point where a great amount of good
news is released in an instant, leading to a possible stock price jump, will occur not so readily
with conservative companies as with less conservative companies. Therefore, this study
predicted that accounting conservatism also has a reducing effect on the likelihood of a stock
price jump. As stated before, the results indeed indicate a reducing effect of accounting
conservatism on the jump likelihood of a company.
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Building on the previously described theory and papers, the results seem to implicate
that accounting conservatism indeed works as a contra mechanism for the opportunistic
incentives of managers to hoard bad news, but it also works as a mechanism that reduces the
release of good news. On one hand it reduces the incentives of managers to hoard bad news,
because of the asymmetrical requirements to recognize bad news as such relatively sooner,
which results in a lower crash likelihood (Kim and Zhang, 2010). On the other hand it also
reduces the release of good news, because of the higher requirements to recognize good news
as such. As can be found in tables 4 and 5, this results in a lower jump likelihood. In short,
accounting conservatism seems to help protect the company from possible costs associated
with a stock price crash, but it also seems to contribute in depriving the company from
possible benefits associated with a stock price jump. Considering this, the desirability of
accounting conservatism is not that easy to assess. This study attempts to further interpret the
results in order to see whether accounting conservatism seems desirable or not based on the
theory introduced in chapter two of this study of LaFond and Watts (2008).
LaFond and Watts (2008) found evidence for a market demand for accounting
conservatism, which extends the frequently addressed explanation for conservatism, namely
contracting. Investors demand conservatism, because it reduces agency costs caused by
information asymmetry, which in turn is caused by the optimism bias. The optimism bias
refers to the incentives of managers to overstate the financial statements, because of for
example opportunistic behavior. In other words, LaFond and Watts (2008) findings
demonstrate that accounting conservatism is more than a means to reduce contracting costs,
but that it is actually a market means that reduces agency costs caused by information
asymmetry. When considering the findings of LaFond and Watts (2008), the results of this
study seem to imply that the jumps of conservative companies are preferred by the market,
because the jumps, even if they occur less, contain relatively less optimism bias.
Subsequently the lower optimism bias results in lower information asymmetry, which in turn
reduces agency costs. Considering this, it seems that the benefits of conservatism by
protecting against possible crash costs should outweigh the costs of missing out on possible
benefits associated with more jumps, because the market demand found by LaFond and Watts
(2008) indicates that agency costs as a whole will decrease.
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When considering the standpoint of the FASB on the contrary, the results could
possibly also implicate that the relatively lower jump likelihood of conservative companies
stems from an interference with the quality of neutrality of accounting. Subsequently the
information asymmetry actually increases leading to increased agency costs. LaFond and
Watts (2008), however, demonstrated that their findings are more robust than the statements
of the FASB (2008). Therefore, this study tends to conclude that conservatism is a desirable
accounting principle with regard to its effects on stock fluctuations and information
asymmetry and agency costs, based on the results of the paper of Kim and Zhang (2010) and
the results of this paper. However, this study suggests that more in-depth future research is
needed in order to thoroughly determine (i) to what extent accounting conservatism is
desirable or not and in specific (ii) whether the reduced effect on jump likelihood should be
seen as an advantage or as a disadvantage.
5. Conclusion
The purpose of this research was to investigate to what extent the level of accounting
conservatism of a company influences the likelihood of a stock price jump of the company.
Prior studies like Jin and Myers (2006), Hutton et al. (2009), Kim and Zhang (2010) and
LaFond and Watts (2008) provided this study with theoretical foundations on which the
following main hypothesis was built: accounting conservatism in financial statements
reduces the likelihood of a future stock price jump, ceteris paribus. An empirircal research
method was employed in the aim to examine this hypothesis. This study extended the paper of
Kim and Zhang (2010) in order to examine the effect of conservatism on the jump likelihood
next to Kim and Zhangs (2010) findings about the effect on the crash likelihood. In addition
a second hypothesis was developed in order to give this study more depth by considering
alternative interpretations. This study first set the background by explaining accounting
conservatism and outlining the more addressed conventional argumentation behind the
reasons of its existence and the newly emerging theoretical findings by LaFond and Watts
(2008). Hereafter, particular studies of interest were further conceptualized in order for this
study to develop its main hypothesis. In addition a second hypothesis was developed in order
to give this study more depth by considering that investors are capable to take into account a
companys conservatism level when assessing the release of good or bad news.
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The empirical analysis of this study found evidence for hypothesis 1a, indicating that
conservatism in fact has a reducing effect on the jump likelihood of a companys stock in the
following year. The empirical analysis did not found evidence for hypothesis 1b, implying
that investors dont seem to react stronger (weaker) to good (bad) news of more conservative
companies relative to less conservative companies. The portfolio analysis actually further
supported the main hypothesis, hypothesis 1a.
Building on the main theoretical link, the results seem to implicate that accounting
conservatism indeed works as a mechanism that reduces the release of good news resulting in
a lower jump likelihood. When combining the result of this paper with the results of Kim and
Zhang (2010), it is not really possible to determine the desirability of accounting
conservatism, because it on one hand help protect the company from possible costs associated
with a stock price crash, but it also seems to contribute in depriving the company from
possible benefits associated with a stock price jump. Bearing in mind, however, that investors
demand more conservative earnings as a means of mitigating agency costs (LaFond and
Watts, 2008, p.476), this study tends to conclude that the benefits of having fewer crashes
should outweigh the costs of having fewer jumps. This study, however, does advocate for
further future research to determine whether information asymmetry and thereby costs as a
whole indeed decrease because of accounting conservatism, because prominent accounting
bodies like the FASB (2008) continue to distance themselves from the principle of
conservatism.
Initially this study intended to include multiple robustness checks. For example this
study wanted to calculate the CSCORE again based on annual cross-section regressions and
this study intended to include an alternative measure for the jump likelihood. Unfortunately,
this study did not manage to include robustness checks because of the times scope of the
thesis in combination with the somewhat limited knowledge of the author with statistical
software. Another possible limitation of this study was its sample size. Initially, this studys
intention was to comprise the years 1962-2013, but because of (i) the time scope of this
masters thesis and (ii) practical limitations the sample needed to be scaled down. A further
limitation is that this study came across a few multicollinearity difficulties between certain
components of the CSCORE measure. The study did not correct for this, because of the
limited time and knowledge of the author. An important note, however, is that the correlations
of the CSCORE fitted with related literature. A last possible limitation is that it was not able
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to include the control variables RET, SIGMA and NCSKEW, because this would have been
in line with related papers (Kim and Zhang, 2010; Hutton et al., 2009; Chen et al., 2001).
These control variables would have been based on the variable W, which is also the basis for
the JUMP variable. Therefore, these control variables would again not have been incorporated
in the initial logistic regression because of multicollinearity problems. Although this study
had to cope with some time and expertise limitations, the purpose of this research is evident.
It contributed to a rather new and emerging branch of the conservatism literature and the
implications of this study are worth deeper investigation. Moreover, the current distancing of
accounting and economic bodies like the FASB from the concept of accounting conservatism
should encourage further in-depth future research. This may be especially important given the
recent economic crisis and the reducing effect of accounting conservatism on stock crashes
(Kim and Zhang, 2010) and the possible reducing effect of accounting conservatism on
agency costs as a whole.
As stated before, the results of this paper are worth to be further investigated. For
example an in-depth analysis that compares the costs associated with crashes to the benefits
associated with jumps could help demonstrate the possible desirability of accounting
conservatism. An interesting future research question could be whether accounting
conservatism has a reduced effect on the total costs associated with crashes and jumps. A
positive answer to this question would then seem to support the findings of LaFond and Watts
(2008); accounting conservatism reduces information asymmetry and thereby agency costs. A
negative answer to this question would then seem to support accounting bodies like the FASB
(2008); accounting conservatism increases information asymmetry and thereby agency costs.
Further it would be interesting to additionally conduct this research on a longer term instead
of only a short term. It is imaginable that a longer research window offers more or even better
insights, because a shorter window for example might not clearly demonstrate to what extent
costs or benefits persist over time.
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Appendix A
Variable definitions
X is proxied by the earnings before extraordinary items divided by the market value of equity.
R is proxied by the yearly stock return compounded from monthly stock returns.
D is a dummy variable that equals one if R is beneath 0, and zero otherwise.
MKV is proxied by the natural log of the market value of equity.
MB is the market-to-book ratio, which is proxied by the market value of equity divided by the
book value of equity, where the market value of equity equals common shares outstanding
multiplied by the annual fiscal closing price.
LEV is the debt-to-equity ratio, which is proxied by the book value of total liabilities divided
by total assets.
rj,t represents the stock return of stock j in week t, which is proxied by the weekly stock
returns compounded from daily stock returns, where the daily stock return is equal to ((daily
stock price/daily adjustment factor) * daily total return factor )[t] /(daily stock price/daily
adjustment factor) * daily total return factor))[t-1]-1)*100)
rm,t represents the market index return in week t, which is proxied by the weekly market
returns compounded from daily market returns.
W is the firm-specific weekly return, which is proxied by the natural logarithm of the residual
of the expanded market index regression (see equation 5) plus 1.
JUMP is a binary indicator that equals one if a company encounters more than one jump
week per (fiscal) year, and zero otherwise. The firm-specific weekly return is denoted as a
jump week if it is 3,2 standards deviations above the mean of the firm-specific weekly returns
for the given fiscal year.
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JUMPt+1 is a binary indicator that equals one if a company encounters more than one jump
week in year t+1, and zero otherwise.
CSCORE represents the conservatism score based on the measure of Khan and Watts (2009)
(see equations 1-4).
SIZE is proxied by the natural logarithm of sales.
DTURN is proxied by the average monthly share turnover per fiscal year t minus the average
monthly share turnover of t-1, where monthly share turnover is proxied by the monthly
trading volume divided by total number of shares outstanding during the month.
ROE is proxied by income before extraordinary items divided by the book value of equity.