Conservatism, optimal disclosure policy, and the timeliness of financial reports

Frank B. Gigler, Thomas Hemmer

Research output: Contribution to journalArticle

132 Scopus citations

Abstract

We develop a theory of the relation between biases in financial reporting and managers' incentives to issue timely voluntary disclosures. We find that firms with relatively more conservative accounting are less likely to make timely voluntary disclosures than firms with less conservative accounting. Therefore, price is more timely in reflecting the news of firms with less conservative accounting. Prior research has assumed that the timeliness by which news is impounded in price is uncorrelated with the nature of accounting earnings and has ascribed a concave earnings-return relation to the accounting system reporting bad news on a more timely basis than good news. In our theory, a concave relation is not necessarily attributable to a difference in the way the accounting system reports good vs. bad news. Rather, our prediction stems from how biases in mandatory financial reports determine which firms optimally choose to make voluntary preemptive disclosures and which do not. Hence, our theory provides an alternative explanation for the empirical findings and cautions against interpreting them as evidence that accounting is conservative. Finally, we identify means of empirically distinguishing between the alternative explanations.

Original languageEnglish (US)
Pages (from-to)471-493
Number of pages23
JournalAccounting Review
Volume76
Issue number4
DOIs
StatePublished - Oct 2001

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