Estimating and Validating a Firm-Year Specific Measure of Conservatism : Australian Evidence

Previous evidence of conservatism in Australian financial reporting, as in other countries, is constrained by the absence of a reliable firm-year specific measure. This paper calibrates such a measure using the procedure outlined by Khan and Watts (2007). We show that the C_Score they propose provides a robust measure of conservatism at the firm-year level. In doing so, we provide new evidence on the existence of conservatism in Australian financial reporting, as well as some of the factors associated with variation in conservatism. The results show that conditional conservatism is a pervasive feature of the Australian financial reporting landscape. C_Score is positively associated with firm size, firm age, stock return volatility, investment cycle length and prior period conservatism, while it is negatively associated with market-to-book ratios and leverage. We view our evidence as collaboration of the measure outlined by Khan and Watts, as well as providing an encouraging start for research into the causes and consequences of conservatism in Australian financial reporting