The Economic Determinants of Conditional Conservatism

Authors

  • Juan Manuel García Lara,

    1. The authors are respectively from Universidad Carlos III de Madrid, Universidad Autónoma de Madrid and IESE Business School, University of Navarra. They gratefully acknowledge helpful comments and suggestions from Peter F. Pope (editor) and an anonymous referee. They are also grateful to Sophia Hamm, conference participants at the 2008 JBFA capital markets conference, the 2008 AAA annual meeting, the 2007 and 2008 EAA annual meetings and the 2007 AECA Congress, and seminar participants at Tilburg University, Instituto de Empresa Business School, University Federico II of Naples and ISCTE Business School. The authors would also like to thank John Graham, who kindly provided estimates for the marginal tax rate. They acknowledge financial assistance from IESE Research Division, the Spanish Ministry of Science and Innovation (ECO2008-06238-C02-01/ECON and SEJ2007-67582-C02-02/ECON), and the European Commission INTACCT Research Training Network (MRTN-CT-2006-035850). (Paper received December 2007, revised version accepted November 2008)
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  • Beatriz García Osma,

    1. The authors are respectively from Universidad Carlos III de Madrid, Universidad Autónoma de Madrid and IESE Business School, University of Navarra. They gratefully acknowledge helpful comments and suggestions from Peter F. Pope (editor) and an anonymous referee. They are also grateful to Sophia Hamm, conference participants at the 2008 JBFA capital markets conference, the 2008 AAA annual meeting, the 2007 and 2008 EAA annual meetings and the 2007 AECA Congress, and seminar participants at Tilburg University, Instituto de Empresa Business School, University Federico II of Naples and ISCTE Business School. The authors would also like to thank John Graham, who kindly provided estimates for the marginal tax rate. They acknowledge financial assistance from IESE Research Division, the Spanish Ministry of Science and Innovation (ECO2008-06238-C02-01/ECON and SEJ2007-67582-C02-02/ECON), and the European Commission INTACCT Research Training Network (MRTN-CT-2006-035850). (Paper received December 2007, revised version accepted November 2008)
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  • Fernando Penalva

    Corresponding author
    1. The authors are respectively from Universidad Carlos III de Madrid, Universidad Autónoma de Madrid and IESE Business School, University of Navarra. They gratefully acknowledge helpful comments and suggestions from Peter F. Pope (editor) and an anonymous referee. They are also grateful to Sophia Hamm, conference participants at the 2008 JBFA capital markets conference, the 2008 AAA annual meeting, the 2007 and 2008 EAA annual meetings and the 2007 AECA Congress, and seminar participants at Tilburg University, Instituto de Empresa Business School, University Federico II of Naples and ISCTE Business School. The authors would also like to thank John Graham, who kindly provided estimates for the marginal tax rate. They acknowledge financial assistance from IESE Research Division, the Spanish Ministry of Science and Innovation (ECO2008-06238-C02-01/ECON and SEJ2007-67582-C02-02/ECON), and the European Commission INTACCT Research Training Network (MRTN-CT-2006-035850). (Paper received December 2007, revised version accepted November 2008)
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* Address for correspondence: Fernando Penalva, IESE Business School, University of Navarra, Av. Pearson, 21, 08034 Barcelona, Spain.
e-mail: penalva@iese.edu

Abstract

Abstract:  We study the economic determinants of conditional conservatism. Consistent with prior literature, we find that contracting induces only conditional conservatism and litigation induces both conditional and unconditional conservatism. We extend prior evidence by Qiang (2007) by showing that taxation and regulation induce not only unconditional conservatism, but conditional conservatism as well. We show that in certain scenarios taxation and regulation create incentives to shift income from periods with high taxation pressure and high public scrutiny to periods with lower taxation pressure and lower public scrutiny. These income shifting strategies are implemented by recognising current economic losses that, given managerial incentives to report aggressively, would not have been recognized otherwise, or by delaying the recognition of current economic gains that would have been recognized had circumstances been different.

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