Get access

The Conservatism Principle and the Asymmetric Timeliness of Earnings: An Event-Based Approach

Authors


  • Accepted by Peter Pope. We thank the editor, anonymous reviewers, Richard Dietrich, Peter Easton, Zhaoyang Gu, Chandra Kanodia, Wayne Landsman, Karl Muller, Doron Nissim, John Phillips, Douglas Schroeder, Rajdeep Singh, Shyam V. Sunder, Rex Thompson, Ivy Zhang, Sudipta Basu (especially), and workshop participants at Columbia University, the University of Minnesota, the Ohio State University, CUNY-Baruch College, George Washington University, the University of Cincinnati, and the University of Texas at Dallas; and participants of the Financial Accounting and Reporting Section Conference, the American Accounting Association National Conference, and the Indian School of Business Conference for valuable comments and suggestions.

Abstract

We test the asymmetric timeliness hypothesis by using information in extreme events as a measure of good/bad news. Our focus on extreme events is motivated by two arguments. First, the accounting concept of materiality in conjunction with litigation risk influences managers and auditors to make more conservative choices with respect to material events. Second, focusing on extreme shocks minimizes the probability that accounting slack may obscure the effect of asymmetric timeliness (Beaver and Ryan 2005). We identify individual events using short-window extreme returns, since long-window returns would aggregate the effect of multiple events and thus limit our ability to detect the asymmetry. Taken together, these features of our research design provide a more powerful test of asymmetric timeliness. Consistent with prior studies, we document that the correlation between bad news and concurrent earnings is significantly higher than that between good news and concurrent earnings. Our analysis of extreme events also enables us to document higher correlation of good news with earnings two or more quarters ahead. This is in contrast to prior studies that were unable to document asymmetry in the relation between returns and subsequent earnings in the opposite direction to that between returns and concurrent earnings. Our paper contributes to the growing literature on conservatism by modifying the Basu methodology to enhance the power of the test of asymmetric timeliness.

Ancillary