Accounting conservatism and the asymmetry in the earnings response to current and lagged returns

I investigate accounting conservatism and its implications for the relation between reported earnings and current and lagged good vs. bad news. The feature of conservatism I investigate is the asymmetric timeliness of earnings---bad news is generally recognized more quickly than good news.; I first investigate the contemporaneous return-earnings relation and the impact of conservatism on this relation vis-a-vis other factors known to influence it. I investigate how different measures of earnings affect the observed asymmetry. I also investigate the effect of positive and negative transitory items on the observed asymmetry. I find that significant asymmetry is apparent with operating income as well as net income; conservatism does not dramatically increase the level of asymmetry as the level of earnings is changed. I also find that the presence of transitory items, whether positive or negative, induces similar asymmetry. This suggests that while conservatism may induce asymmetry, it is induced by other factors as well.; I also examine asymmetry in the relation between earnings and lagged returns; extant literature generally ignores this and implicitly assumes either a simple model of conservatism in which bad news is contemporaneous in returns and earnings or that asymmetry in lagged returns is not important. I find that significant asymmetry exists in lagged positive and negative returns. Conservatism does not force the immediate recognition of bad news; the market anticipates a significant portion of bad news before it is included in earnings. This is consistent with the standard of verification for the recognition of losses resulting in the deferral of losses.; Finally, I examine the role of risk in the asymmetry in the relation between earnings and positive and negative, current and lagged returns. This is motivated in part by extant literature that identifies risk as a significant determinant of the return-earnings relation as well as by the Financial Accounting Standards Board's definition of conservatism as a prudent reaction to uncertainty and risk. Using four proxies for risk, I find that there is greater asymmetry in the relation between earnings and current and lagged returns when risk is high.