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faculty: "FEB" and publication year: "2010"
| Author||S. Bissessur|
|Title||A framework for conservatism and measurement in financial reporting|
|Publisher||Amsterdam Business School, University of Amterdam|
|Faculty||Faculty of Economics and Business|
|Institute/dept.||FEB: Amsterdam Business School Research Institute (ABS-RI)|
|Abstract||There is controversy regarding the role of conservatism in financial reporting. Watts (2003) argues that conservatism is an important mechanism the resolves conflicts between owners and managers in a firm. However, in the current Exposure Draft on the Conceptual Framework for Financial Reporting, conservatism is not considered a desired characteristic. I present a framework for the demand for conservatism, based on the model of income measurement by Demski and Sappington (1990). In this framework, unbiased income measurement can be fully revealing. However, if unbiased information disclosure is inadequate, a conservative transformation is a cost effective adjustment to income measurement with preservation of full revelation. Conservatism is thus considered to be a link between the measurement approach and the information approach to income measurement. I empirically test the framework for the agency cost related to debt contracts as a specific setting that isolates the demand for conservatism in financial reporting. Debt holders can engage in firm specific contract, and therefore may not require firms to be conservative with respect to the recognition of good news relative to bad news. Results show that high agency cost related to debt contracts result in higher demand for conservative information. This results hold after controlling for other incentives for conservatism. Results suggest that conservatism is a cost-effective contracting mechanism, and contrast the position of the IASB that conservatism is an undesirable characteristic in financial reporting.|
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