| This paper examines the determinants and economic consequences of discretionary accounting conservatism. Discretionary accounting conservatism is defined as managerial choices of accounting methods and estimates within Generally Accepted Accounting Principles (GAAP) that result in the persistent understatement of cumulative reported earnings and net assets over a period of time. First, I empirically test the set of factors purported by Watts (2003a) as determinants of discretionary conservatism. This set of determinants relates to incentives arising from contracting, litigation, tax and political costs. Second, I examine whether discretionary conservatism is beneficial to firms in terms of reducing these costs. Specifically, I examine the relations between discretionary conservatism and the cost of debt and operating cash flows. I find evidence consistent with the contracting, litigation, tax and political costs explanations for discretionary accounting conservatism. In addition, even after controlling for potential problems with endogeneity and reverse causality, I find firms with higher levels of discretionary conservatism have higher debt ratings and higher operating cash flows. |
