The Mechanism Of Influences On Investors' Investment Decision Processes Caused By Accounting Conservatism

Investors give the most weights to valuation when they make stock investmentdecisions, which are majorly based on financial accounting information. Priorresearches demonstrated that the essence of stock price returns is a process thatincorporates all future economics profits discounted by the hurdle rate. Under thistheme, the most urgent thing that investors face is how could they translate accountingprofits into their economic counterparts, which is an active debate in major academia.Especially after the Enron's bankruptcy, regulation authorities enforced a set of codesto ensure the conservatism of accounting practice of listed companies, whichdeteriorate the situation. Is accounting earnings information relevant? This questiongained central focus. Under this background, this paper reviewed and analyzed extantliteratures and developed empirical models to test the above question by usingfinancial accounting and analysts' forecasts data of China's main board listedcompanies from2002to2010. This study originate from prior accountingconservatism studies, tested the correlations between accounting conservatism andthree major aspects, which are firstly the estimation of economics profits measured asIRR, secondly the relevance of the fundamental signals and lastly the investmentintensity of firms and following consequences. However, this paper differs fromBasu(1997) study, which devised a proxy to measure the existence of accountingconservatism. I began this study from the basics of accounting matching behaviors,because it is the very place where conservatism principle works, which is essentiallyhow to confirm revenues and expenses. Extant literatures made deep and thoroughstudy on the revenue recognition process, namely earnings management. The focus ofthis paper is the process of expense confirmation process. Through empirical studies, Ifound:First, there is a reverse link between the volatilities of the difference of IRR andARR and the magnitude of precise expense matching. A proper matching makes ARRa fine proxy for IRR. And a decrease in the gap between IRR and ARR makes earningsinformation timelier, which means a larger current earnings response coefficient and asmaller future earnings response coefficient.Second, the magnitude of matching significantly correlated to the predictionpower of fundamental signals, but the link to non-accounting signals such asextraordinary capital expenditure growth was weak. There is trivial evidence thatmarket participants like analysts responded differently on the fundamental signals of aproper matching company. There is significant incremental explanatory power offundamental signals for the analysts' forecast errors, which was confirmed byregressions under a larger time frame. Third, residuals from estimation of changes in former investment intensity weremore volatile. And there is a map between the earnings growth and the current or priorchange of investment intensity. For the most conservative quintile, a1%increase ofinvestment intensity propels earnings by1.8%.