Strategic emphasis and accounting conservatism

Abstract

PurposeThe authors examine how a firm's strategic emphasis (SE) on value appropriation (VA) over value creation (VC) is associated with accounting conservatism.Design/methodology/approachTo examine the effect of SE on a firm's adoption of conservative accounting practice, the authors measure SE as advertising expenses minus research and development (R&D) expenses scaled by total assets. The authors rely on the asymmetric timeliness of earnings from Basu (1997) to measure conditional conservatism and investigate how the incremental sensitivity of earnings to negative stock returns varies with the SE.FindingsSE on VA over VC is found to be positively related to accounting conservatism since they want to deter entrants (i.e. competition adjustment) and to accommodate the tighter monitoring over the financial reporting system from stakeholders (i.e. risk adjustment). This argument is also supported by the additional cross-sectional tests based on the different level of market competition and external monitoring environment. In addition, the positive association between SE on VA over VC and accounting conservatism is less pronounced when managerial overconfidence is high.Research limitations/implicationsImplication is that two important decisions (i.e. SE and accounting conservatism) are related with each other since both are to create competitive advantage and to maintain financial stability for a firm, and the relation differs by managerial characteristics.Originality/valueThis study highlights the differential roles of SE in shaping the conservatism in financial reporting and the importance of overconfidence in driving conservative accounting.