Conservative Accounting Choice Under Asymmetric Information: Efficiency Of Contracts, Risk Of Decision And Improvement Of Valuation

Conservatism is the traditional accounting principle in recognition and measurement, and it influenced accounting practice and accounting theory for centuries. It is generally accepted that the stakeholder can benefit from the conservative report. After 1990s, foreign researchers began to focus the cause of accounting conservatism, how to measure conservatism and economic consequences of accounting conservatism. But, in China, the researchers began to focus the field in 2004. Although domestic researchers confirmed the persistence of accounting conservatism in China, the study on the economic consequences of accounting conservatism is not very thorough. Thus, based on the former conclusion, this paper analyses the effect of conservatism principle in China. Specifically, by analysis on the influence that conservative information made on the decision of shareholders, creditors and managers, the paper makes a judgment on company's economic consequences of accounting conservatism in China, and evaluates its effect on allocation efficiency.The paper discusses three questions, namely the functions of conservatism in enhancing debt efficiency, improving investment decision and improving valuation. Thus, the paper can make the judgment that the use of conservatism in protection creditors'interests, reducing managers'decision risk and improving investors'evaluation efficiency on the market.(1) the relation between conservatism and efficiency of debt, cost of debtFirstly, based on the framework of signal revelation, the paper proves that the relation between conservatism and debt contract efficiency is determined by the degree of information asymmetry between company and creditor, which means that only if the degree of information asymmetry is high enough, conservatism could play the function of signal revelation, then company's more conservative means higher debt contract efficiency and lower cost of debt.Secondly, the paper gives the evidence that supports the hypothesis of conservatism's debt contract. The paper finds that, in China, the company's degree of conservatism is negative correlation to the degree of conflict of interest between creditor and shareholder in dividend distribution, namely, the more severe conflict is, the more conservative the company is. In addition, the paper also finds that, in China, when the interest rate of debt has completed its marketization, conservatism has played the function of decrease the cost of debt, that is, controlling the other factors, the more conservative company gets the lower interest rate of debt.That is to say that after the marketization of interest rate, the bank has obtained more freedom in contracting, thus the bank can evaluate the risk of debt contract, then confirm the rate. In the other words, the conservatism's function of protection creditor's interest brings into play, and conservatism enhances the efficiency of debt contract.(2) the relation between conservatism and efficiency of manager's investment decisionFirstly, the paper analyses the predominance of conservative accounting information (relative to the aggressive accounting). By two real option model, the analysis consequence shows that either conservative accounting or aggressive accounting may be the better choice, but the choice is determined by the risk of investment, the schedule of investment, etc. That is to say, conservative accounting information can improve the efficiency of investment in certain degree.Secondly, the paper gives the evidence that conservatism improving the efficiency of investment. Specifically, the degree of conservatism of company in China is negative correlation to both overinvestment and underinvestment. In addition, from the sample of additional offering, the degree of conservatism is also negative correlation to the cost of equity capital, that additionally supports the conclusion of conservatism reduces the underinvestment.The conclusion of this part says that the accounting information under conservatism reduces the risk of investment in China, thus constrains the manager's opportunism behavior of investment on bad projects, and constrains overinvestment. At the same time, conservative information reduces the risk of investment, so the investor's request to return is reduced, thus will bring lower cost of equity capital and alleviate the company's underinvestment.(3)the relation between conservatism and protection of investor's interest, improvement of market valuationFirstly, the paper analyses the function of conservative accounting information in protection investor's interest and enhancing the efficiency of market valuation. By the analysis on how conservatism constrain speculation and overvaluation, the conclusion shows that bias conservative accounting has predominance over unbiased accounting in the imperfectly market, that is conservative accounting constrains the speculation and overvaluation (the market mostly is), thus protects investor's interest, and brings forward the higher efficiency of valuation on the market.Secondly, the paper gives the evidence that conservatism improving the efficiency of evaluation on the market. Specially, the conclusion shows that although conservatism reduces the persistence of earnings in a certain extent, no evidence shows that conservatism reduces the relevance of earnings. On the contrary, from the full sample, conservatism is not exactly positive correlation to the relevance of earnings, but from the controlling sample (moderate degree of conservatism), conservatism is exactly positively correlation to the relevance of earnings.That is to say, conservatism enhance the earnings quality some extent, and it has the function to improve market valuation and supply valuable information of earnings for investors'evaluation.