A Study Of The Determinants And Economic Consequences Of Accounting Conservatism

Accounting information is a numerical language that is used to reflect financial position, operating performance and cash flows of a company. Accounting information influences investors'behavior and investment and financing behavior of companies, and finally influences the efficiency of economy. Accounting conservatism, as a basic principle of accounting recognition and measurement, has affected accounting practice for a long time, and recently became much stronger in firms. So it is one of important standards to measure the quality of accounting information (Watts,2003a). The existence of accounting conservatism results from the demand from capital market. Information users can benefit from conservative accounting information. Therefore, this paper studies accounting conservatism.After reviewing the related papers about accounting conservatism, the author finds out several valuable research topics. First of all, auditors can influence the generation process of conservative accounting information. So how independent auditing influences accounting conservatism is an important research topic. The oversea researchers have made research on this topic from the perspective of characteristics of auditing firms, non-auditing service of auditing firms, and rotation of auditors. But domestic researchers just study how the scale of auditing firm affects accounting conservatism. As a result, this topic should be studied from more perspectives. Based on the regulation that a certified public accountant can audit a firm for at most 5 consecutive years, this paper studies how a certified public accountant's tenure and rotate affect accounting conservatism of Chinese listed firms. The results can provide empirical evidence for the effect of this regulation.Secondly, with respect to the economic consequence of accounting conservatism, there is little oversea empirical evidence and even no paper about this topic published on top domestic academic journals. Accounting information of high quality can influence the investment and financing behavior of firms, and finally enhance the efficiency of economic resource allocation. So, as a basic character of accounting information, accounting conservatism may affect the investment and financing behavior of firms. This paper takes the advantage of institution and disclosure regulation of our country to investigate how accounting conservatism influences the investment and financing behavior of Chinese listed firms. The results can provide Chinese capital market based empirical evidence about the economic consequence of accounting conservatism.This paper is made up of seven chapters.Chapter 1:Introduction. This chapter introduces the research motivation, research objective, research arrangement.Chapter 2:Introduction of Accounting Conservatism. This chapter introduces the related principles of accounting conservatism, including the definition and the classification of accounting conservatism, and the reasons for survival of accounting conservatism.Chapter 3:Review of Accounting Conservatism. This chapter reviews the related published papers of accounting conservatism, including the measurement methods and empirical research. The former is the methodology basis of this paper. And the latter is the foundation to find valuable research topics.Chapter 4:Certified Public Accountant's Tenure, Rotation and Accounting Conservatism. This chapter investigates how CPA tenure and rotation influence the accounting conservatism of Chinese listed firms. The results show that the audit tenure of CPAs is significantly negative related with accounting conservatism. And this phenomenon mainly exists in the companies that are of less economic importance for the audit firms by which the CPAs are employed. These results illustrate the necessity of the Rotation Regulation. However, after the listed firms change the CPA who has audited the firm for 5 consecutive years, the accounting information of the listed firms does not become more conservative. This result shows that Rotation Regulation does no have effect to improve the audit quality. It illustrates that Rotation Regulation requests the listed firm to change the CPAs who provide audit service for the firm for 5 consecutive years, but this rotation happens to the CPAs in a same audit firm. The successor employed by the same audit firms can not improve auditing standard and auditing independence. And the auditing quality for client firms does not improve significantly. So the effect of Rotation Regulation is weakened at last. These findings supply empirical support for the improvement of the regulation. Rotation Regulation should require both CPA and audit firms to rotate at the same time.Chapter 5:Accounting Conservatism and Investment Behavior of Listed Firms. Because of agency problem, firms have two kinds of inefficient investment behavior, overinvestment and underinvestment. This chapter investigates the influence of asset write-off on investment efficiency of Chinese listed firms. The results show that asset write-off is significantly negative related with inefficient investment expenditure. This provides evidence to illustrate that asset write-off can curb overinvestment and cause underinvestment. After differentiating firms with overinvestment and underinvestment, this chapter also finds that in both overinvestment firms and underinvestment firms, asset write-off can reduce the investment expenditure of next year. These results illustrate that conservative accounting policy can control overinvestment. These findings provide a new method to solve overinvestment problem for listed firms. Meanwhile, accounting conservatism can also lead to underinvestment. So this principle should be implemented with caution.Chapter 6:Accounting Conservatism and Financial Constraint of Listed Firms. This chapter studies the influence of accounting conservatism on financial constraint of Chinese listed firms. Based on the methods developed by Almeida et al (2004) and Whited and Wu (2006), this chapter tests the relationship between accounting conservatism and financial constraint. The results show that more conservative accounting method may make firms more financially constrained. Further analysis shows that accounting conservatism is negatively related to the loans borrowed from banks, and is also negatively related to the likelihood of raising capital through SEO or right issue. These findings suggest that accounting conservatism may have negative effect on economic efficiency. So this accounting principle should be used with caution. These findings also provide support for fair value measurement. Fair value measurement requires symmetrical recognition of losses and gains, which does not lead to biased estimate of firm value. So fair value measurement can avoid this negative economic consequence to some extent.Chapter 7:Conclusion. This chapter summarizes the main conclusions of the above three chapters, contributions and limitations, and finally provides several topics of further study. The contributions of this paper are as follows:Firstly, this paper uses accounting conservatism to measure audit quality, and investigate the influence of audit tenure and mandatory audit rotation on audit quality from the perspective of CPA tenure and CPA mandatory rotation. Generally, most related papers use discretionary accruals to measure audit quality. Because accounting conservatism can enhance contract efficiency (Watts,2003a), and is used as a strategy of risk management by companies and audit firms after Enron scandal (Krishnan,2007). So this paper uses accounting conservatism to measure audit quality. Relative to the related domestic research, this is a new method. What's more, as a result of the limitation of information disclosure, the U.S. research on audit tenure and audit rotation can only take the advantage of the information about audit firm tenure. But in China, listed firms disclose information about both audit firms and CPAs. So this paper investigates the influence of audit tenure and mandatory audit rotation on audit quality from the perspective of CPA tenure and CPA mandatory rotation. This method is consistent with the requirement of Rotation Regulation. So the results can provide more reliable empirical evidence for the enforcement effect of the regulation and some lessons for the improvement of U.S. Rotation Regulation.Secondly, this paper investigates the economic consequence of accounting conservatism from the perspective of investment and financing behavior.In order to explore the economic consequence of accounting conservatism, the paper study the influence of accounting conservatism on investment behavior and financing behavior of Chinese listed firms. This study takes a step to fill the domestic research gap in this area, provides some Chinese capital market based empirical evidence about the economic consequence, and contributes to promote general research about how accounting conservatism affect economy efficiency.Third, this paper improves the research method of Bushman et al (2006), and provides a new method to solve overinvestment problem. Based on the theoretical view that accounting conservatism can curb overinvestment, Bushman et al (2006) tests the influence of accounting conservatism on the sensitivity of capital expenditure on tobin's q on the country level. Although what they find support the above view, the research method they use have endogenous problem. This paper takes full advantage of the asset write-off information of Chinese listed firms, and selects research sample in only one country, analyzes the asset write-off and investment behavior of individual firm, and meanwhile control the economic condition of the sample firms. This method solves the endogenous problem to some extent. Besides, this paper confirms that asset write-off can affect managers' incentives, and finally curb overinvestment. This finding provides a new method to solve overinvestment problem.Finally, this paper provides some evidence that accounting conservatism may have negative effect on economy efficiency, and gives some suggestion for companies to use accounting conservatism principle properly. Besides that accounting conservatism can enhance economy efficiency, this paper also finds that timely recognition of losses can lead to underinvestment and financial constraint. This finding illustrates that accounting conservatism may have negative effect on economy efficiency. So this principle should be implemented with caution. If a firm has much more cash flows and capital expenditures, in order to prevent manager from overinvesting, the board should require the firm to adopt more conservative accounting policy. If a firm has few cash flows and capital expenditures, accounting policy should not be much more conservative; otherwise underinvestment may happen to the firm. What's more, if a firm has more investment opportunities, accounting policy should not be much more conservative; otherwise the development of the firm may be constrained due to lack of external capital.