excludes the control variables; and column 2 includes both the SHORT-related and LONG-related variables and the control variables. In each of the two columns, the estimated coefficient of RET⋅DR is significantly positive (all p-valuesb0.10). The estimated coefficient of PIN⋅RET⋅DR is also significantly positive in each column (p-valuesb0.05).
Our discussion centers on the estimated coefficients of four tenure-related variables (β10, β11,β14, andβ15,). These four coefficients can be grouped according to whether or not their variables interact with DR or not. The examined variables that do not interact with DR (β10
and β14) capture how the relation examined in this study (i.e., between information asymmetry and conservatism) is affected by auditor tenure when firms get good news. A positive (negative) β10 shows that the relation between PIN and conservatism decreases
Table 5
A further examination of whether auditor tenure affects the information role of conservatism.
NIt =β0 +β1DRt +β2RETt +β3RETt⋅DRT +β4PINt +β5PINt⋅DRt+β6PINt⋅RETt +β7PINt⋅RETt⋅DRt
SHORT * PIN *DR 0.303(0.062) 0.240(0.033)
SHORT * PIN*RET (β10) 1.730(0.040) 1.662(0.037)
SHORT * IN*RET*DR (β11) −2.127(0.345) −2.069(0.304)
LONG* PIN −0.089(0.382) −0.109(0.261)
LONG* PIN *DR −0.130(0.019) −0.179(0.003)
LONG* PIN*RET (β14) 0.402(0.182) 0.374(0.189)
LONG*P IN*RET*DR (β15) −1.065(0.025) −1.110(0.013)
Leverage 0.052(0.174)
Notes: SHORT, a dummy variable, is equal to one if tenure is shorter than four years, otherwise, it is equal to zero;
LONG, a dummy variable, is equal to one if Ttenure is longer than 10 years, zero otherwise. Other variables are as defined in Table 2 and Table 3, and reported numbers in parentheses are the two-tailed p-, which have been adjusted by firm-cluster standard error.
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(increases) with short auditor tenure when firms are faced with good news. In other words, a positive (negative)β10implies that, all other things being equal, the observation ofLaFond and Watts (2008)that greater (lower) gains will be reflected in earnings if the level of PIN is greater, is actually weaker (stronger) when auditor tenure increases. Our column 1 shows a significantly estimated coefficient of SHORTt⋅PINt⋅RETt (1.730, p-valueb0.05) and Column (2) also shows a significant result (1.662, p-valueb0.05), meaning that, in the case of good news, short tenure significantly affects reported earnings when their PIN scores increase.
A positive (negative) β14, on the other hand, shows that the relation between PIN and conservatism decreases (increases) with long auditor tenure when firms are faced with good news. The estimated coefficients of LONGt⋅ PINt⋅RETt in column 1 (0.402, p-value = 0.182) and in column 2 (0.374, p-p-value = 0.189), however, are both insignificantly positive. To sum up, when firms face good news, auditor tenure affects the observation of LaFond and Watts (2008)that lower gains will be reflected in earnings if the level of PIN is greater. However, their claim is weaker when auditor tenure is shorter, at least according to Taiwanese data.
The results in cases of bad news, however, are not identical. The examined variables – SHORT and LONG – that do interact with DR (β11 andβ15) capture how the relationship between information asymmetry and accounting conservatism is affected by auditor tenure when firms face bad news. Using β11as an example, we can see that a positive (negative) estimated result for the estimated coefficients of those variables shows that the observation of LaFond and Watts (2008)that greater (lower) losses will be reflected in earnings if the level of PIN is greater is stronger (weaker) when SHORT equals one. The interpretation of β15 is similar to that ofβ11, except for focusing on cases where LONG equals one.
InTable 5, the estimated coefficient of SHORTt⋅PINt⋅DRt(β15) is insignificant in both column 1 (–2.127, p-value=0.345) and column 2 (–2.069, p-value=0.304). This evidence implies that the effect of PIN score on accounting conservatism is not affected when audit tenure is short and firms face bad news.
The estimated coefficient of LONGt⋅PINt⋅RETt⋅DRt(β15), however, is significant both in column 1 (–1.065, p-valueb0.05) and in column 2 (–1.110, p-value b 0.05). Taken together, these findings for auditor tenure extend LaFond and Watts (2008)by examining whether and how this factor influences the relation between information asymmetry and conservatism. Specifically, using the middle tenure group as a benchmark, we find that short and long tenure have disparate impacts. When tenure is short, we find support for the contention that good news is incorporated into earnings earlier, but this effect is not significant with long auditor tenure. For the case of bad news, however, it is long auditor tenure that shows significant results: with long auditor tenure, bad news is incorporated into earnings later; with short auditor tenure, this effect is not significant.
6. Conclusion
LaFond and Watts (2008) explain and find evidence that information asymmetry between firm insiders and outside equity investors generates conservatism in financial statements. They conclude that accounting conservatism increases firm value. However, the disparate degree of accounting conservatism around the world calls for an investigation into
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the role of conservatism in different countries and into the factors that affect this role.
Therefore, by using the LaFond and Watts (2008) method on Taiwanese data, this study investigates the information role of conservatism and refines the conclusions of LaFond and Watts by examining whether auditor tenure affects the information role of conservatism.
We find evidence that the information role of conservatism is also supported in Taiwan, but only in cases of bad news. In addition, our evidence reveals that the effect of PIN– which according to LaFond and Watts (2008) causes good (bad) news to be incorporated into earnings later (earlier)– is actually weaker in cases of good news when tenure is short as well as in cases of bad news when tenure is long, at least according to Taiwanese data.
This study is useful because the differences in institutional settings may invalidate the conclusions of LaFond and Watts (2008), which are based only on U.S. data. Using a Taiwanese data set, this study investigates the cause-and-effect relation between information asymmetry and accounting conservatism. Our empirical evidence suggests that conservatism mitigates information asymmetries.
Specifically, we find evidence that accounting conservatism is positively related to the level of and changes in information asymmetry. In sum, conservatism, one of the most prominent characteristics of financial accounting, is actually an efficient way to address the moral hazard problem arising from the asymmetric information among interested stakeholders. In this regard, we suggest that the IASB/FASB Conceptual Framework Project should examine carefully the economic role of conservatism further before making their final decision. One immediate concern is this: if conservatism is no longer structured into the financial reporting standards, how will the IASB and FASB technically deal with the uncertainty that a company faces when preparing its accounts? The advantage of conservatism as a useful earning attribute for creditors and outside equity holders will vanish after the removal of accounting conservatism in financial statements. However, the economic demand for conservatism (e.g., Watts, 2003a, b) still exists in all stakeholders.
Although we hesitate to conclude that the IASB's and FASB's statement was hastily made without serious academic input, we believe that the IASB and FASB have not formally taken into consideration how to compensate lenders and borrowers (e.g., Zhang, 2008) as well as stockholders (e.g., LaFond & Watts, 2008) for the lost benefits of conservatism.
Thus, our findings are inconsistent with the current proposal of IASB and FASB that such conservatism should be excluded from the qualitative characteristics of accounting information. Indeed, it is our opinion that a final decision on such an exclusion should be made only after serious consideration of academic input. Even if standard setters such as the FASB and IASB continue to ignore relevant research, shareholders can still keep our results in mind: at the very least, this paper suggests that if conservatism is excluded from the qualitative characteristics of accounting information, shareholders should closely monitor information asymmetry.
Acknowledgements
We gratefully acknowledge the comments and suggestions of Fan-Hua Kung, Fujiing Shiue, T.J. Sellari, Jianling Wang, Kevin Chen (Co-Editor), Taychang Wang, the participants at the twelfth (2008) Accounting and Management Symposium across the Taiwan Strait (Sian, China; where this paper won the Best Paper Award), as well as
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workshop participants at Chung Yuan Christian University, National Taipei University, and Peking University. Our anonymous reviewer provided many especially insightful suggestions. Wuchun Chi gratefully acknowledges financial support from the National Science Council (Project No. NSC 96-2416-H-004-035-MY3).
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