Can unconditional conservatism be opportunistic? Evidence from subsequent real earnings management at Business groups

Description

By focusing on the more pervasive unconditional conservatism, we provide fresh insights into how conservatism can be detrimental to financial reporting quality. We examine whether unconditionally conservative (UC) firms engage in greater real earnings management (REM) to meet or beat earnings benchmarks (MBE). UC firms are expected to be prudent, with persistently lower earnings. REM, on the contrary, is a costly approach, with long-term consequences, used to manipulate earnings upward. As expected, we find that UC firms exhibit higher discretionary expenses. However, UC firms suspected of engaging in MBE reduce these expenses (REM) by 0.5 to 2 percent of earnings. Our results reveal differences in manipulation strategies across organizational forms: group-affiliated UC firms use this strategy more opportunistically. Stronger monitoring reduces the level of REM in UC firms. Additionally, accrual manipulation and insider ownership influence a UC firm’s REM choices. Thus, decisions to manage real earnings and adopt conservative reporting policies may be intertwined, contributing to the debate on whether conservatism reduces reporting quality. Our findings highlight opportunistic behavior and the real costs associated with conservatism, which is counterintuitive and raises important concerns for regulators, standard setters, and policymakers.

Publication Date

1-1-2017

Keywords

Prudence, Financial reporting quality, Opportunism, Monitoring, International financial reporting standards (IFRS), Emerging markets, Business groups, Insider ownership, India

Conference

Journal of Accounting, Auditing and Finance Conference, 25-27 June, 2017, University of Otago, Dunedin, New Zealand

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