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Three essays on conservative reporting and capital markets

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2020-05
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2020-07-23
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This thesis consists of three studies that examine the feedback e_ect of capital markets in general, and capital market participants in particular, on the quality of accounting information provided by firms. Specifically, I concentrate on the intersection of conservative accounting practice and equity price eficiency. I am particularly keen on analyzing the effect of conservative reporting on the dissemination of information to capital markets and whether firms benefit from such accounting practice. Additionally, I study how the accumulation of conservative accounting practices affects the information provided in the balance sheet and how capital markets react to such information. In Chapter 1 (co-authored with Beatriz Garcia Osma), we try to tackle the concern that conservatism might increase information asymmetry. Particularly, lower timeliness of good news recognition can lead to incorrect inferences regarding a firm's prospects from the side of investors. This fact echoed in FASB (2005; 2010), where it was argued that conservatism may trigger information asymmetry between informed and uninformed equity investors. To understand whether the timeliness of bad and good news conservative recognition differently affects information asymmetry, we take the case of insider trading. In particular, we predict that accounting conservatism influences insiders' opportunities to speculate on good and bad news, and thus, insider trading profitability. We find that greater conditional (unconditional) conservatism is associated with lower (higher) insiders' profitability from sales. We find limited evidence that conservatism influences profitability from purchases. These findings are consistent with our hypotheses on the different informational roles of conditional and unconditional conservatism, and on the asymmetric influence of conservatism over the opportunities to speculate on good versus bad news. Our research design takes into consideration the endogenous nature of insiders' trading and conservatism. The results are robust to different measures of conservatism and a number of additional analyses. In Chapter 2 (co-authored with Beatriz Garcia Osma and Juan Manuel García Lara), we take a further step in the analysis of information environment that is generated through conservative reporting. In particular, we examine the benefits of conditional conservatism for equity markets. We predict that conservatism helps market participant to assess firm's equity underlying value, and mitigates bad news hoarding, thereby improving the information efficiency of stock prices. Consistent with our prediction, we find that conservatism lowers the probability of sustained duration of equity overvaluation and reduces abnormal short-selling interest. We also document lower penalties for conditionally conservative firms when they miss earnings forecasts, both in the mid- and short-run. This is consistent with equity markets applying a lower discount for uncertainty to conservative firms. We corroborate our findings exploiting the passage of SFAS 121 as a plausible exogenous shock to conditional conservatism. Finally, in Chapter 3 (solo authored), I study how and when the accumulation of conservative accounting properties in balance sheet numbers might be beneficial for firms. In particular, I argue that balance sheet conservatism (BSC) was instrumental in alleviating the adverse consequences of the recent financial crisis. I identify two main properties of BSC-firms that led to better performance during the crisis: the informational and cushioning. I document that high BSC-firms raised more capital and obtained lower cost of debt, due to the former property and reduced earnings volatility and experienced less assets write-downs, due to the latter. Next, I study whether these translated into a better performance during the crisis. I find that high BSC-firms outperformed low BSC-firms both in terms of raw and four-factor model adjusted returns. Further, I document that firms with higher BSC passed liquidity shocks with lower reductions in investment, employment and productivity. Overall, BSC benefited both share- and debtholders. Additionally, I conduct an out of sample test exploiting the Great Depression setting and also find that high BSC-firms outperformed low BSC-firms.
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