Research On Accounting Conservatism And Business Investment Efficiency

After MM (1959)’s perfect capital theory, a large number of empirical studies under the condition of giving up MM assumptions find the firm’s investment is positively related to internal cash flow significantly, which is explained from two points of view in literatures domestic and abroad:one is financial constraint hypothesis due to information asymmetry in capital market, the other is free cash flow hypothesis due to agency conflict. Whatever the explanation, the investment-cash flow sensitivity embodies the firm’s inefficient investment. Efficient investment is the source of economic growth, and at the micro-level the firm’s investment efficiency more determines its sustained profitability and long-term development ability. Therefore, how to govern inefficient investment has very important theoretical and practical significance. At present, domestic scholars have studied the effects of such factors as ownership, corporate governance, financial development and others on investment-cash flow, but studies from the perspective of the relation between accounting information, especially accounting conservatism and investment efficiency are very scarce, and lack of depth. So, this paper deeply studies the relation between accounting conservatism and investment efficiency in order to provide rationale for governing inefficient investment.On the basis of related literatures, in combination with China’s institutional background, this paper uses data of China’s listed companies in2002-2006to empirically test the relation between accounting conservatism and investment-cash flow sensitivity after classifying the samples into two groups:one tending to overinvest, the other tending to underinvest, and further investigate the effects of the nature of the property right on the relation between accounting conservatism and inefficient investment. According to the result of the aforementioned test, from the perspective of demand for accounting conservatism this paper also empirically investigates whether the listed companies may actively increase the demand for accounting conservatism in face of overinvestment of free cash flow, and whether the nature of the property right may impact on the demand. The results are as follows: (1)Accounting conservatism can curb overinvestment of free cash flow. Accounting conservatism has the function of corporate governance because of its timely loss recognition, so it can reduce manager’s incentive to invest in negative NPV project before investing, motivate manager to give up investing in bad projects after investing, and contribute to the supervision of the broad, creditors and others. Our empirical investigation into the selected sample indicates accounting conservatism reduces the overinvestment of free cash flow. Furthermore, as government-controlled listed companies and non-government-controlled listed companies face different agency problems, controlling by government can play an active role in the relation between accounting conservatism and overinvestment.(2)Accounting conservatism can aggravate underinvestment caused by financial constraint. While in theory accounting conservatism can alleviate underinvestment by reducing the adverse selection caused by financial constraint and contributing to resolve the problem of costly external finance. But, if external capital-providers can’t distinguish accounting conservatism, accounting conservatism may not be priced, and on the contrary, by leading to the underestimation of profit and net assets, accounting conservatism may adversely affect the financing, thus exacerbating the underinvestment. Our empirical investigation indicates accounting conservatism exacerbates the underinvestment caused by financial constraint, and this effect is due to the negative impact of accounting conservatism on financing. Furthermore, market-oriented relation between claims and liabilities can’t be established between listed companies controlled by government and commercial banks, so the negative effect of accounting conservatism on underinvestment is reduced in list companies controlled by government.(3)The firms in face of overinvestment of free cash flow may increase the demand for accounting conservatism. As mentioned earlier, accounting conservatism can curb overinvestment, so the firms in face of overinvestment could increase the demand for accounting conservatism, and our empirical investigation affirms this assertion. Furthermore, since the government-controlled firms have the characteristics of diversified goals, soft budget and others, controlling by government may reduce the demand for accounting conservatism.Based on the above results of study, this paper recommends some constructive suggestions:to deeply study the economic consequences of accounting conservatism, and to develop a set of accounting standards suitable for China in the process of gearing to international accounting; to improve and perfect market infrastructure of Chinese listed companies’ financial reporting and disclosure system so as to create a favorable environment for the application of conservative accounting; to strengthen corporate internal governance, and improve the corporate governance mechanisms which can effectively restrict major shareholders from acquiring private benefits of control through violating minority shareholders’ interests so that accounting conservatism may play more efficient role in governing inefficient investment.