Identifying accounting conservatism in the presence of skewness

• Published in: Review of quantitative finance and accounting 2024-02, Vol.62 (2), p.553-577
• Main Authors: Jarva, Henry, Lof, Matthijs
• Format: Article
• Language: English
• Subjects: Accounting; Accounting procedures; Accounting/Auditing; Conservatism; Corporate Finance; Earnings; Econometrics; Economics and Finance; Endogenous; Expected values; Finance; Operations Research/Decision Theory; Original Research; Rates of return; Regression analysis; Simulation; Skewness; Validity
• ISSN: 0924-865X; 1573-7179
• DOI: 10.1007/s11156-023-01210-y

The asymmetric timeliness (AT) coefficient as a measure of accounting conservatism has been subject to much debate. We clarify the conditions under which the AT coefficient identifies accounting conservatism in the presence of skewness. Specifically, using an extensive simulation-based approach, we examine the joint impact of return skewness, earnings skewness, and return endogeneity. We show that skewness of returns and earnings distorts the AT coefficient as a measure of conservatism when returns are endogenous. While earnings skewness is a predicted consequence of conditional conservatism, return skewness is arguably unrelated to conservative reporting and cannot be tackled by simple skew reducing transformations or outlier-robust estimators. Empirically, we analyze AT and skewness of firms sorted on size and MTB, highlighting the importance of constant skewness across groups for accurate comparisons of accounting conservatism.