Financial Distress and the Earnings-Sensitivity-Difference Measure of Conservatism
Following Basu (1997), the difference between the sensitivity of accounting earnings to negative equity return (a proxy for bad news) and its sensitivity to positive equity return (a proxy for good news) has been interpreted as an indicator of conditional accounting conservatism. However, some have raised concerns that the earnings-sensitivity difference (ESD) may be affected by factors other than conditional conservatism, and that this may impair its reliability as an indicator of conditional conservatism. Motivated by such concerns and by recognition that the effect of financial distress could contribute to an ESD through a conditional-conservatism route and/or through a non-conditional-conservatism route, we examine the association between the ESD and financial distress. By decomposing the association into an element arising from accruals, which can reflect conditional conservatism, and an element arising from cash flow from operating activities (CFO), which cannot directly reflect conditional conservatism, we seek evidence as to whether such association arises through a conditional-conservatism route or through a non-conditional-conservatism route We find that positive association between the ESD and financial distress arises primarily through the accruals component of earnings rather than through the CFO component, consistent with it arising primarily because of a higher degree of conditional conservatism in relatively financially distressed firms. The inference that there is a positive association between financial distress and conditional conservatism is supported by other non-equity-return-based measures of conditional conservatism. Our results suggest that the effect of financial distress does not impair the reliability of the ESD as an indicator of conditional conservatism.
Year of publication: |
2010
|
---|---|
Authors: | Hsu, A ; O'Hanlon, J F ; Peasnell, K V |
Publisher: |
The Department of Accounting and Finance |
Saved in:
Saved in favorites
Similar items by person
-
Hsu, A, (2010)
-
Financial distress and the earnings-sensitivity-difference measure of conservatism
Hsu, A, (2011)
-
Hsu, A, (2010)
- More ...