Accounting Conservatism Trends and Financial Distress: Considering the Endogeneity of the C-Score

Abstract

To consider a firm's characteristics endogeneity and thereby determine its trend toward accounting conservatism, which in turn affects its financial distress, this study adopts the two-stage least squares approach. The first stage involves investigating the effect of the corporate characteristics on accounting conservatism. The empirical results indicate that financial distress and accounting conservatism exhibit a positive correlation. With respect to the non-financially distressed company, the accounting conservatism of the financially-distressed company is higher. The second phase in the logistic regression is to explore the relationship between the accounting conservatism trends and financial distress. The empirical results indicate that the trends and volatility of the accounting conservatism are significant and positively related to the financial distress, which may be due to the recognition of the company's annual loss on one occasion or the accountants' role in the function of exercising external oversight, thus increasing the company's accounting conservatism. According to the empirical results of this study we have found that the accounting conservatism trends of different company characteristics helps to determine the signs of financial distress. It is recommended that within the management of the company's operations the users of financial statements be aware of the trend and volatility of the accounting conservatism. This is of particular importance due to the probable development of the relevant decision-making processes of the company's stakeholders.

Does Accounting Conservatism Still Exist in Disruptive Era? The Mars Approach

“…Based on these results, the first hypothesis of the study which predicts the level of financial difficulties affects accounting conservatism is proven to be true, the higher the level of financial difficulties will further reduce the level of accounting conservatism. This result is in line with the results of previous studies by [4] and [5].…”

“…Conservatism is the principle of caution so that with financial difficulties, companies will be more careful in facing uncertain environments. Thus, the higher level of financial difficulties of financial companies will encourage managers to raise the level of accounting conservatism, and vice versa if the level of low financial difficulties of managers will reduce the level of accounting conservatism [4], and another study concluded that the level of financial difficulties has an effect on accounting conservatism [5].…”

The Influence of the Financial Distress, Conflict of Interest, and Litigation Risk on Accounting Conservatism

“…Financial distress is measured by the criteria of bankruptcy using Altman Model (1968) by measuring the form of the Z-score (Altman, 1968;Kao & Sie 2016;Chung, et al, 2003). This study using the Z-score, because it deals directly with the financial ratio that shows the company's performance in the financial statements (Kao & Sie, 2016). Z-score formula for manufacturing companies expressed in the equation:…”

“…Conservatism made at the time of the company's hesitation facing Factors influencing accounting conservatism is a financial distress. Financial distress caused due to delays in payment of the debt, the failure to pay a debt when the contract extension expires, suspension, demands or litigation (Kao & Sie 2016;Chung, et al, 2003). Positive Accounting Theory (PAT) shows that the existence of financial distress lowering of accounting conservatism (Demonier, et al, 2015;Bertomeu, et al, 2015).…”

“…IRCEBvalue of -1,10 or criteria <1,23(Kao & Sie 2016). This happens because the criteria for sample observation was performed at manufacturing companies are experiencing financial difficulties in a row.Litigation risk is measured by the DER has a minimum value of -6,93 indicates that the sample of firms making losses or accumulation of losses in a row.…”