The Earnings-Sensitivity Difference as an Indicator of Conditional Conservatism: Evidence from U.K. Earnings Components
Following Basu (1997), the excess of the sensitivity of accounting earnings to contemporaneous negative share return over its sensitivity to contemporaneous positive share return (the earnings-sensitivity difference (ESD)) has been widely interpreted as an indicator of conditional-conservatism-induced asymmetric timeliness in earnings. Although this interpretation is supported by substantial evidence that the ESD is associated with likely contracting-related demands for accounting conservatism, concerns have arisen that the ESD measure may reflect factors not directly related to conservatism, and that this may adversely affect its validity as an indicator of that phenomenon. This paper contributes to the literature on the ESD by examining whether the ESD for a sample of U.K. firms reporting under FRS 3: Reporting Financial Performance arises from earnings components that, in light of accounting regulation and practice, are likely to be affected by conditional conservatism or from other components that are not likely to be affected by conditional conservatism. Although a substantial proportion of the ESD emanates from cash flow from operating and investing activities (CFOI), which cannot directly reflect accounting conservatism, its incidence across other components of earnings is predominantly consistent with the conditional-conservatism interpretation of the ESD.
Year of publication: |
2010
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Authors: | Hsu, A ; O'Hanlon, JF ; Peasnell, KV |
Publisher: |
The Department of Accounting and Finance |
Saved in:
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