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The effect of accounting conservatism on firm valuation

Yonpae Park, University of Nebraska - Lincoln


Using the accounting valuation model proposed by Feltham and Ohlson [1995], this study examines firm valuation attributable to (1) the joint effects of accounting conservatism and extent of voluntary disclosures on firm valuations and (2) the joint effects of accounting conservatism and life-cycle stages. ^ Although prior studies have concluded that voluntary disclosures provide value-relevant information not captured in the reported financial numbers, these studies were conducted assuming the credibility of voluntary disclosures was similar across all firms. Research has also concluded that the value of information is directly related to its precision (inverse of variability) or the credibility of its source. However, all voluntary disclosures are not equally credible, and voluntary disclosures from sources with questionable credibility are likely to have minimal or no effect on firm valuation. Therefore, studies on the value-relevance of voluntary disclosures should be examined jointly with their credibility. Since prior studies have not considered this previously omitted variable, the findings of those studies are not generalizable to other situations. ^ Unlike reported financial numbers, voluntary disclosures are not audited nor have an ex ante governance mechanism. Investors' perception of the credibility of voluntarily disclosed information is likely derived from their perception of the credibility of the firm's other information. When a firm follows conservative accounting procedures, investors are likely to regard the firm as being conservative not only in preparing financial numbers but also in releasing voluntary disclosures. Investors will give more credibility to those firms' voluntary disclosures, as compared to firms that are not deemed as conservative. Therefore, the effects on firm value will be greater for those firms whose disclosures are considered more credible. This study predicts for firms following conservative accounting procedures, the impact of voluntary disclosures on market values will be greater than those firms following less conservative accounting procedures. Results confirm that accounting conservatism enhances the credibility of a firm's voluntary disclosures to investors, resulting in greater value relevance of the voluntary disclosures. ^ Prior empirical research also suggests that the value relevance of financial numbers is affected by firms' underlying economic attributes. Furthermore, Feltham and Ohlson [1995] describe theoretically that, under conservative accounting, the expected growth in net assets affects firm values. This study predicts that the effect of accounting conservatism on equity market value will be different for firms with different economic attributes. This study uses a firm's life-cycle stage as the surrogate representing the firm's economic attributes. The effect of life-cycle stage, as perceived by market investors, on market values and the interaction between accounting conservatism and life-cycle stage are examined. The results suggest that the impact of accounting conservatism on firm valuation interacts with a firm's life-cycle stage. ^

Subject Area

Business Administration, Accounting

Recommended Citation

Park, Yonpae, "The effect of accounting conservatism on firm valuation" (2002). ETD collection for University of Nebraska - Lincoln. AAI3074093.