Accounting Conservatism And Inefficient Investment

Accounting conservatism is one of the basic accounting principles. Basu defined it as" the accountant’s tendency to require a higher degree of verification to recognize good news as gains than to recognize bad news as losses" in1997. Nowadays, scholars study accounting conservatism in two ways:demand motive and economic results. Under the circumstance that the convergence between China enterprise accounting principles and international enterprise principles has occurred, new accounting principles was executed in Jan.1st,2007,which extended the scope of application of fair-value measurement attribute. In this context, I discuss the relationship between accounting conservatism and inefficient investment.Inefficient investment includes over-investment and under-investment. Over-investment means that managers invest in negative NPV projects to satisfy their private interests. Under-investment means that managers forgo positive NPV projects to avoid private costs. Both over-investment and under-investment do harm to corporate capital allocation.In this paper, based on C-Score method by Khan and Watts and the model to measure expected investment by Richardson, I take empirical methods and select financial data of A shares listed companies in SSE from2008to2010to test whether and how accounting conservatism affects over-investment and under-investment. It turns out that accounting conservatism is negatively related to over-investment when companies own sufficient free cash flow, and also negatively related to under-investment when companies are short of free cash flow.Six parts are included in this paper. First is introduction, which states the research background and practical significance of this paper and briefly summarize the previous research work across the world. In the second part, I analyze the theory and build hypothesis. Based on the cash flow theory, the information asymmetry theory, the agency problem, accounting conservatism and their relationships with inefficient investment, I build the hypothesis of the paper. In the third part, I explain the data source and its standard. Meanwhile I define and illustrate dependent variables, independent variables and control variables. In the fourth part, I analyze the empirical results in three ways:correlation analysis, descriptive statistic and empirical results. The fifth part is robustness test, for the purpose of controlling the systerm deviation of expected investment model and endophytism. In the sixth part, I report the results and put forward advise based on the analysis above.This paper contributes a little to the literature in three ways. In the first place, I use both quantitative and qualitative methods to measure accounting conservatism. How to properly measure accounting conservatism is an important issue. If the chosen measurement method is not appropriate, the results of the paper will be questioned. On the basis of previous research works, I decide to choose C-Score method to qualitatively measure accounting conservatism due to the fact that it fits the development of China Stock Market most. Meanwhile, to straighten the deviation made by choosing measurement method, I choose the Accured Cash Flow Methods to quantitatively measure accounting conservatism.In the second place, I choose data from2008to2010, which is full of timeliness. Previous research work on the economic results of accounting conservatism mainly choose data before2007,ignoring the impact of new enterprise accounting principle on accounting conservatism thus lack of timeliness. However, choosing data from2008to2010effectively avoid this problem.Last but not least, enriches the research on accounting conservatism and Nowadays researches on accounting conservatism in our country are not so much. Most of them focus on the needs motivation of conservatism, while researches on the economic results of accounting conservatism are less. In the context of our special systerm environment, research on the economic results of accounting conservatism illustrates how accounting conservatism affects capital allocation in different economic environments.However, I only test how accounting conservatism optimizes corporate capital allocation through its impact on over-investment and under-investment. As to other channels to optimize corporate capital allocation, for example, strong minority investor rights and whether individual stock prices are impounded into more firm-specific information, are not involved. Further, I only focus on whether and how accounting conservatism affects corporate capital allocation, the extent to its impact on corporate capital allocation are not mentioned.