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A Note on the Time Series Measure of Conservatism

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  • Sebastian Brauer
  • Frank Westermann

Abstract

Asymmetric persistence of accounting income is often tested in a regression of changes in earnings on lagged changes in earnings, including an interaction term for negative changes (see Basu [1997] or Ball et al. [2009] for a recent overview). In this note we propose an alternative, but closely related measure of conservatism - regressing the changes in earnings on the lagged levels, similar to the threshold-unit root test specification of Enders and Granger [1998]. We argue that this approach has three distinct advantages compared to the conventional setup: (i) a smooth, non-oscillating impulse response pattern to an unexpected shock in earnings (ii) a return to the old equilibrium of earnings in the long run and (iii) it can be extended to higher order autoregressive processes. We illustrate the differences between the two approaches, when applied to a common data set of firms, as well as a data set from a Monte Carlo simulation.

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Bibliographic Info

Paper provided by CESifo Group Munich in its series CESifo Working Paper Series with number 2968.

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Date of creation: 2010
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Handle: RePEc:ces:ceswps:_2968

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Keywords: timely loss recognition; asymmetric persistence; conservatism;

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References

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  1. Yin-Wong Cheung & Menzie D. Chinn, 1996. "Further Investigation of the Uncertain Unit Root in GNP," NBER Technical Working Papers 0206, National Bureau of Economic Research, Inc.
  2. Windmeijer, Frank, 2005. "A finite sample correction for the variance of linear efficient two-step GMM estimators," Journal of Econometrics, Elsevier, vol. 126(1), pages 25-51, May.
  3. Enders, Walter & Granger, Clive W J, 1998. "Unit-Root Tests and Asymmetric Adjustment with an Example Using the Term Structure of Interest Rates," Journal of Business & Economic Statistics, American Statistical Association, vol. 16(3), pages 304-11, July.
  4. Ball, Ray & Shivakumar, Lakshmanan, 2005. "Earnings quality in UK private firms: comparative loss recognition timeliness," Journal of Accounting and Economics, Elsevier, vol. 39(1), pages 83-128, February.
  5. Arellano, Manuel & Bond, Stephen, 1991. "Some Tests of Specification for Panel Data: Monte Carlo Evidence and an Application to Employment Equations," Review of Economic Studies, Wiley Blackwell, vol. 58(2), pages 277-97, April.
  6. John Y. Campbell & N. Gregory Mankiw, 1987. "Permanent and Transitory Components in Macroeconomic Fluctuations," NBER Working Papers 2169, National Bureau of Economic Research, Inc.
  7. Ball, Ray & Watts, Ross, 1972. "Some Time Series Properties of Accounting Income," Journal of Finance, American Finance Association, vol. 27(3), pages 663-81, June.
  8. Ali, Ashiq & Zarowin, Paul, 1992. "Permanent versus transitory components of annual earnings and estimation error in earnings response coefficients," Journal of Accounting and Economics, Elsevier, vol. 15(2-3), pages 249-264, August.
  9. Ball, Ray & Robin, Ashok & Wu, Joanna Shuang, 2003. "Incentives versus standards: properties of accounting income in four East Asian countries," Journal of Accounting and Economics, Elsevier, vol. 36(1-3), pages 235-270, December.
  10. Basu, Sudipta, 1997. "The conservatism principle and the asymmetric timeliness of earnings," Journal of Accounting and Economics, Elsevier, vol. 24(1), pages 3-37, December.
  11. Luis A. Gil-Alana & Rolando Pelaez, 2008. "The Persistence of Earnings per Share," Faculty Working Papers 08/08, School of Economics and Business Administration, University of Navarra.
  12. White, Halbert, 1980. "A Heteroskedasticity-Consistent Covariance Matrix Estimator and a Direct Test for Heteroskedasticity," Econometrica, Econometric Society, vol. 48(4), pages 817-38, May.
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Cited by:
  1. Sebastian Brauer & Carl-Friedrich Leuschner & Frank Westermann, 2011. "Does the Introduction of IFRS Change the Timeliness of Loss Recognition? Evidence from German Firms," Working Papers 87, Institute of Empirical Economic Research.

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