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Accounting Conservatism and Firm Investment Efficiency

Beatriz García, Juan M. Garcia Lara () and Fernando Penalva
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Juan M. Garcia Lara: Department of Business Administration Universidad Carlos III de Madrid
Fernando Penalva: IESE Business School, University of Navarra.

No 1004, Working Papers from Departament Empresa, Universitat Autònoma de Barcelona

Abstract: Conservatism, through the timelier recognition of l osses in the income statement, is expected to increase firm investment efficiency through three main channels: (1) by decreasing the adverse effect of information asymmetries between outside equity holders and managers, facilitating the monitoring of managerial investment decisions; (2) by increasing managerial incentives to abandon poorly performing projects earlier and to undertake fewer negative net present-value investments; and (3) by facilitating the access to external financing at lower cost. Using a large US sample for the period 1990-2007 we find a negative association between conservatism and measures of over- and under- investment, and a positive association between conservatism and future profitability. This is consistent with firms reporting more conservative numbers investing more efficiently and in more profitable projects. Our results add to a growing stream of literature suggesting that eliminating conservatism from accou nting regulatory frameworks may lead to undesirable economic consequences.

Keywords: Conservatism; earnings asymmetric timeliness; inves tment efficiency; overinvestment; underinvestment. (search for similar items in EconPapers)
JEL-codes: G10 G31 M41 (search for similar items in EconPapers)
Date: 2010-01, Revised 2010-01
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Published in Working Papers at the Department of Business, January pages 1-60

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