The Link between Conditional Conservatism and Cost Stickiness

Abstract

As a prominent characteristic of financial reporting, conditional conservatism has received great attention in the empirical financial accounting literature. Since financial reporting standards require a higher verification for the recognition of good compared to bad news, Basu (1997) argues that earnings will reflect bad news faster than good news. He assumes that if markets are efficient unlike earnings, returns will reflect good and bad news equally fast. Accordingly, he finds a stronger earnings-returns relation for bad news than for good news, branded as the asymmetric timeliness of earnings (see figure 1).