How Managers’ Ability to Gather Information Can Affect the Value of Conservative Accounting

Academics and practitioners, including lawyers, emphasize the importance of conservative accounting to lenders and corporate boards, allowing them to intervene and take corrective actions at an early stage. However, conservative accounting may also increase the risk of false alarms and prompt excessive interventions. In light of this downside, the overwhelming and in many cases unconditional support that conservative accounting often receives is puzzling.

We aim to reconcile the support for conservatism with the concern for false alarms by showing that managers’ ability to gather additional evidence following accounting reports changes the balance between the benefits and costs of conservative accounting. … Read more