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The confounding effect of cost stickiness on conservatism estimates

Rajiv D. Banker, Sudipta Basu, Dmitri Byzalov and Janice Y.S. Chen

Journal of Accounting and Economics, 2016, vol. 61, issue 1, 203-220

Abstract: Sales decreases affect earnings more than sales increases because of cost stickiness. We hypothesize that this correlated omitted variable constitutes a confounding effect in standard asymmetric timeliness models. Controlling for a piecewise linear effect of sales changes in these models decreases the measured asymmetric timeliness significantly and changes inferences about the average level of conservatism and the extent of cross-sectional variation in conservatism. Validation tests confirm that the asymmetry for sales changes is consistent with sticky costs and is distinct from conditional conservatism. Future empirical research on conditional conservatism should recognize the potential confounding effect of sticky costs.

Keywords: Timely loss recognition; Omitted variable bias; Overinvestment (search for similar items in EconPapers)
JEL-codes: D21 D23 M40 M41 (search for similar items in EconPapers)
Date: 2016
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Journal of Accounting and Economics is currently edited by J. L. Zimmerman, S. P. Kothari, T. Z. Lys and R. L. Watts

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