International Review of Financial Analysis 20 (2011) 88102

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International Review of Financial Analysis

Accounting disclosures, accounting quality and conditional and

unconditional conservatism
George Emmanuel Iatridis
University of Thessaly, Department of Economics, Volos, Greece
Accounting and Auditing Oversight Board, Ministry of Economics, Athens, Greece

a r t i c l e i n f o a b s t r a c t

Article history: This study investigates the motives of UK listed companies when reporting high and low quality accounting
Received 17 December 2010 disclosures. It also examines the relation between the quality of published nancial statements and earnings
Received in revised form 20 February 2011 management practises, for example, low quality accounting disclosures might be linked to earnings man-
Accepted 21 February 2011
agement. The paper further studies the relation between nancial reporting quality and the timely disclosure
of losses and difcult-to-verify accounting items, i.e. conservatism. The focus here is on conditional and
JEL classication:
unconditional conservatism, their association and the variables that inuence the asymmetric disclosure of
M41
losses. The ndings indicate that rms that display high quality accounting disclosures generally exhibit
Keywords: higher size, protability and liquidity measures. Firms that experience a change in management or are audited
Accounting disclosures by a Big-4 auditor also tend to report high quality disclosures. High quality disclosers tend to display higher
Accounting quality capital needs and to engage less in earnings management. The study shows that they display greater
Conditional conservatism conditional conservatism and less unconditional conservatism. The ndings demonstrate that the conditional
Unconditional conservatism form of conservatism is negatively related to unconditional conservatism, as the former tends to enhance
Managerial opportunism contracting efciency, while the latter might facilitate managerial opportunism. The study provides evidence
Earnings management
of asymmetric disclosure of losses for rms with high leverage. The same holds for high quality disclosers that
display bad news. In contrast, rms that are in a growth phase are found to provide less conservative and less
difcult-to-verify accounting information in order to inuence their growth prospects.
2011 Elsevier Inc. All rights reserved.

1. Introduction efcient decisions. They should reinforce investors' understanding

According to the International Accounting Standards Board (IASB),
reported accounting information should possess the following
qualitative characteristics. It should be relevant and assist users in
evaluating past, present, and future events. It should be reliable, free
from material error and presented faithfully. Reported accounting
information should also be comparable, consistent and understand-
able in the way it is presented. Information to be included in the
nancial statements should be material in the sense that its potential
misstatement or omission might inuence signicantly the decision-
making of users. The disclosure of accounting policies employed in the
preparation of the nancial statements should be clear and accom-
panied by explanatory information on any changes in those policies.
Recognition, measurement and disclosure of nancial information can
affect companies' market picture and nancial situation, and would
therefore require their utmost attention and consideration.
The nancial statements should be designed to provide valid and
relevant accounting information in order to assist users in making
94 Vassani Street, Volos, 38 333, Greece. Tel.: + 30 6973 963626.
E-mail address: giatridis@econ.uth.gr.
of a company's nancial position, changes in nancial position and
results of operations. The reported nancial information should reect
on the quality and value relevance of earnings and should be sup-
ported by appropriate quantitative and qualitative evidence. The
nancial statements should provide disclosures about the critical
assumptions and estimates relating to accounting items and issues
that are highly uncertain as well as about estimates that would have
a material impact on the presentation of the company's nancial
position and results (see Conover, Miller, & Szakmary, 2008). Like-
wise, it is vital to identify the items in the nancial statements that
are likely to be affected by the accounting estimates. The reported
accounting information should be forward-looking and should mirror
the company's future nancial prospects and the likely future effects
of potential and known risks and uncertainties. Disclosures are vital
where uncertainties and risks exist that might materially affect the
company's nancial situation. For example, items, such as loan agree-
ments or other arrangements that might trigger payment acceleration
or require additional collateral, circumstances that might impede
the company's ability to engage in transactions that are nancially
benecial or maintain a certain credit rating, level of earnings or cred-
itability, should be explicitly disclosed and discussed in the nancial
statements.

1057-5219/$ see front matter 2011 Elsevier Inc. All rights reserved.
doi:10.1016/j.irfa.2011.02.013
 G.E. Iatridis / International Review of Financial Analysis 20 (2011) 88102
Information asymmetry between managers and stakeholders would
reduce (uninformed) investors' bid prices for company shares. At
the same time, a manager's (potential) concentration in manipulating
contract-based accounting numbers would lead to higher agency costs
and lower rm value (LaFond & Watts, 2008). The considerations set
out above would call for nancial reporting of high quality and less
subjectivity. Higher accounting quality in nancial reporting would be
accompanied by higher conservatism and less information asymmetry
(Ball & Shivakumar, 2005). Given managers' incentives to report good
news, conservatism, which is the asymmetric disclosure of accounting
information, i.e. reporting losses in a more timely fashion than prots,
would make loss disclosures more credible than prot disclosures.
Also, debt covenants embedded into debt contracts would encourage
conservatism as they monitor reported numbers' validity and integrity
(Watts & Zimmerman, 1986). Therefore, conservative accounting
would facilitate monitoring of managerial behaviour as well as efcient
corporate governance mechanisms, since monitoring by board mem-
bers, nancial analysts, investors and other stakeholders would make
managers more careful when producing veriable accounting informa-
tion (Beekes, Pope, & Young, 2004; Garcia Lara, Garcia Osma, & Penalva,
2007).
Firms with high accounting quality in their reported disclosures
would be expected to provide stakeholders with veriable information
about losses, nancial failures and other unfavourable nancial events
that are depicted on nancial accounts and affect a company's per-
formance. It follows that less veriable information would be easier to
be manipulated and would also be less useful to users, reducing thereby
the overall wealth of both managers and shareholders. Thus, high
quality disclosers would apply conditional conservatism, which relates
to disclosures of difcult-to-verify accounting information, and restrict
unconditional conservatism, which is news-independent and relates
to opportunistic managerial endeavours (Basu, 2005). In contrast, rms
that provide low quality accounting disclosures would be more likely to
apply unconditional conservatism practises in order to promote their
managerial objectives, especially when subjectivity drives their deci-
sions. For example, in the case of losses and large stock price declines,
managers may be inclined to write asset values down in order to use
the resulting reserve to inuence future earnings streams (Jiraporn,
Miller, Yoon, & Kim, 2008). Alternatively, in the case of information
asymmetry, rms may use discretionary accruals in order to reduce
earnings volatility and tax obligations or increase management bonuses.
Unconditional conservatism might also be preferred in order to reduce
litigation risks and obtain better terms of nancing especially when rms
experience nancial distress (Coppens & Peek, 2005).
The manager's reputation, remuneration and future in the com-
pany, and the company's share price are to a large degree affected by
the company's published nancial statements and accounting-based
contracts (LaFond & Watts, 2008). Hence, rms would have different
motives for conditional and unconditional conservatism. So, depend-
ing on managerial motives, the restriction of earnings management or
unconditional conservatism practises would vary and would have
differential effects on nancial reporting quality. However, (condi-
tional) conservatism may not be driven only by the rm's efforts
to reinforce the quality of their reported numbers, but also by other
factors that are related to the decision to report accounting in-
formation of high quality, such as size, stock market visibility and
analyst following, leverage, litigation and agency costs and growth
(Cano-Rodrguez, 2010).
In the Review of Narrative Reporting by UK Listed Companies,
The Accounting Standards Board (2009) reports that 76% of their
sample companies provided discussion of their nancial performance
and position. 94% of their sample provided some nancial key per-
formance indicators (KPIs), while 32% of the sample did not disclose
any non-nancial KPIs. 92% of their sample outlined some objectives
or strategies, or both. 66% of the sample reported their risk exposures.
However, only 6% of the sample provided risk-related information
89
with signicant decision-usefulness. Only 38% of the companies
provided a critical discussion of nancial trends and factors. The ASB
reports that it is not clear whether 52% of the sample presented
information on contractual arrangements correctly and in consistency
with the regulation.
In the 2007 Narrative Reporting Survey, PricewaterhouseCoopers,
(2007) have shown that 75% of the FTSE 350 constituents provided
explicit disclosures about their KPIs. 75% of companies provided clear
descriptions of their principal risks and uncertainties. 35% of
companies presented quantitative along with qualitative nancial
information. 42% of companies linked their KPIs with their strategy.
The 2007 Black Sun research reports a signicant improvement in the
disclosure of business objectives and strategy by FTSE 100 constitu-
ents to 98% from 40% in the previous year. Similarly, 88% of companies
presented information on market trends, while 43% of the companies
supported their qualitative nancial information with quantitative
gures. The Black Sun research has also found that 73% of institutional
investors appreciate the provision of additional disclosures in
companies' annual reports, while 87% of them believe that high
quality accounting disclosures are likely to positively affect a
company's nancial performance and outlook (Black Sun, 2007).
The investigation of the sample annual reports shows that UK
rms may in certain cases fail to clearly present and link their
objectives to their strategies and vice versa. Empty statements, such as
our effort is to grow, should be avoided. The business and nancial
structure should be presented along with methodologies, models and
procedures that are in place. The focus of disclosures tends to be on
protability rather than on cash ow. Firms report too many KPIs
creating confusion and misleading users of accounting information.
Firms present KPIs in isolation from the rest of the report without
providing cross-references or critical links to strategy and targets.
Firms ood the annual report with economic and non-economic
information to describe nancial events and transactions or the
economic environment that may be immaterial and irrelevant to
users' decision-making. Information on how managers' actions and
decisions are monitored is found to be infrequently included in the
annual report.
Given the current world economic situation, rms would be
expected to discuss their exposure, economic reaction and defence
mechanisms to liquidity risk. Few rms, however, appear to display
satisfactory managerial information on the world economic downturn.
All sample companies provide disclosures about their risk exposures.
However, they present too many risks and limited quantiable in-
formation with regard to the nature and impact of risks on company
nancial position. Critical disclosures, such as estimates and assump-
tions, management judgement, sources of risks and uncertainty, appear
to be narrative and are not accompanied by numbers or other numerical
descriptions. In their effort to attract investors' condence to their
nancial statements and enhance the value relevance of their reported
accounting numbers, rms should provide quantications of their
narrative disclosures. On the other hand, rms provide ample numerical
data in the notes to the accounts, without presenting appropriate
evidence or explanations.
Given that the quality of nancial reporting and the content of
accounting disclosures vary from rm to rm, the study focuses on UK
listed companies and examines the motives for the provision of high
quality accounting disclosures. Higher accounting quality would be
expected to lead to higher levels of investor condence and to easier
access to stock and debt capital. Hence, studying the motives for
providing higher or lower quality disclosures would shed some light
on managerial behaviour and would provide explanations for their
intentions. For example, the need to obtain equity or debt nancing
might encourage the preparation of a higher quality annual report.
The study also investigates the relation between accounting quality
and earnings management. It would be expected that rms that
provide accounting information that reects the decisions and actions
90 G.E. Iatridis / International Review of Financial Analysis 20 (2011) 88102
of managers in a reliable manner would be less involved in earnings
management practises.
High quality accounting disclosures and annual reports would
provide a means of verifying the reported balance sheet and prot
and loss gures. Here, the study explores the relation between con-
ditional and unconditional conservatism and examines whether high
quality disclosers display higher or lower conditional and uncondi-
tional conservatism. In countries with strong investor protection
mechanisms, such as the UK, conditional conservatism would be
more evident (see Francis & Wang, 2008). The study further tests
the relation between earnings conservatism and reporting quality, by
investigating whether in the light of high quality accounting dis-
closures, less prots and/or more losses are reported. The study also
explores how major accounting variables, such as growth options and
leverage, may inuence conservatism.
The ndings of the study indicate that rms that display high
quality accounting disclosures generally exhibit larger size and
market visibility and higher protability and liquidity. Also, their
higher capital needs and nancial obligations motivate them to
prepare nancial statements of higher quality. In general, rms that
experience a change in management and/or are audited by a Big-4
auditor tend to report accounting information of high quality. High
quality accounting disclosers also appear to recognise large losses
more timely and to engage less in earnings management. The study
has found that conditional conservatism is positively related to
accounting quality. It is found that high quality disclosers display
greater conditional conservatism and less unconditional conserva-
tism, which would further reinforce the superiority and value of the
reported accounting information of these rms as opposed to low
quality disclosers. The ndings report that the conditional form of
conservatism is negatively related to unconditional conservatism, as
the former tends to enhance contracting efciency, while the latter
might facilitate managerial opportunism. The study provides evidence
of asymmetric disclosure of losses for rms with high leverage. The
same holds for high quality disclosers that display bad news. The
ndings also show that rms that are in a growth phase tend to
provide less conservative and less difcult-to-verify accounting
information in order to inuence their growth prospects.
The remaining sections of the study are as follows. Section 2 presents
the background of the study. Section 3 shows the research hypotheses.
Section 4 describes the data and the company categorisation criteria.
Section 5 discusses the empirical ndings, and Section 6 presents the
conclusions and implications of the study.
2. Background considerations
2.1. Managerial opportunism
The rm's contractual arrangements, such as manager's compen-
sation and compliance with debt covenants, the reputation of the
manager and his/her quest for better compensation schemes and/or
position, and the rm's stock return performance affect managerial
behaviour (Lambert, 2001). Hence, they subsequently inuence the
information content of nancial statements (Fields, Lys, & Vincent,
2001). Managers may present favourable nancial numbers during
their term at the management of the rm or increase prots and
reduce losses (Watts, 2003). Unfavourable nancial results, large
losses and stock price drops may lead to managerial decisions that
seek to inuence earnings of future accounting periods. Managers
may also seek to transfer earnings from good to bad accounting years.
Managers may be inclined to inate their earnings in order to be
able to sell their holdings and stock options at higher rates, implying
that managerial ownership may have a signicant effect on earnings
management considerations (Beneish, 1999; Chen, 2005). Alterna-
tively, managerial reputation may make the manager of a rm to
commit to the nancial objectives and interests of the rm's stake-
holders and eventually reduce information asymmetry. This would
imply that managers' reputation and compensation would be adversely
affected if the manager acted against the best interests of the rm (Smith
& Watts, 1982).
Managers are likely to structure their decision-making and nancial
reporting so as to meet investors' expectations and nancial analysts'
forecasts (Healy, Hutton, & Palepu, 1999; Lang & Lundholm, 1996;
Levitt, 1998). Firms may manipulate their prots by altering their
accounting methods, inuencing the estimates and assumptions of
key accounting gures, exercising judgement and subjectivity, or even
misappropriating assets and manipulating formal business documents
and reports (Comer, 1998; Worthy, 1984). Items, such as cash, inventory
and related party transactions, often require judgement, and therefore,
may be associated with opportunistic managerial behaviour (SAS No. 47
Audit Risk and Materiality in Conducting an Audit; Vanasco, 1998).
Likewise, the mispresentation and manipulation of nancial statements
may also involve overstating revenues and assets by intentionally
misrecording revenues, inuencing provisions for bad debts, the value
of property, plant and equipment, misstating accounts receivable by
recording unearned sales, etc (Beasley, Carcello, & Hermanson, 1999;
Fanning & Cogger, 1998; Summers & Sweeney, 1998). Additional
examples involve mismatching sales with cost of sales in order to ma-
nipulate the gross prot margin, or reporting inventory at values other
than those required by law (Spathis, Doumpos, & Zopounidis, 2002).
In the attempt to avoid debt covenant violation, nancial distress
and/or bankruptcy, rms with high leverage may behave opportu-
nistically and not reliably present the reported nancial numbers
(Persons, 1995). In contrast, Frankel and Roychowdhury (2006) have
found that rms with high leverage would tend to present more
informed nancial statements in order to impress lenders. These
ndings imply that managerial behaviour and/or potential opportun-
ism would vary and they would depend upon rms' economic and
nancial situation and position. According to Watts (1993), litigation
may also be a driving force for disclosing more informative nancial
numbers. Also, less protable rms may be reluctant to provide
revealing information in their annual reports in order to avoid scrutiny
and political attention (Spathis et al., 2002). Generally, companies that
experience low asset-related and sale-related returns would generally
be inclined to manipulate their accounting numbers in order to exhibit
better nancial measures (Beasley et al., 1999; Summers & Sweeney,
1998).
Opportunistic phenomena and behaviours can be associated with
managers' personality and inuence, such as for example their rela-
tionship with company auditors, the company's business environ-
ment and economic conditions, the nature of the company's operating
and nancing activities and transactions (SAS No. 82 Consideration
of Fraud in a Financial Statement Audit; Gibbins, Richardson, &
Waterhouse, 1990; Spathis et al., 2002). Bell and Carcello (2000)
argue that the risk factors that seek to capture the likelihood of op-
portunistic nancial reporting include weak internal control systems,
inadequate nancial performance, excessive focus on short-term -
nancial objectives and investors' perceptions ignoring the long-term
perspective of the rm, ownership structure, etc.
The potential opportunistic behaviour that might be expressed by
managers is likely to be associated with the private information that
they possess and which they might use to the detriment of investors
and for their own benet. The possession of private information would
lead to buying or selling decisions aiming at the maximisation of
managers' interests. In a similar vein, information asymmetry might lead
uninformed investors to incorrect and loss-making decisions. Large
quantities of private information would be associated with large bid-ask
spreads and lower stock returns for uninformed investors (Amihud &
Mendelson, 1986; Easley & O'Hara, 2004). In contrast, rms with high
nancial reporting quality and less information asymmetry appear to
display lower bid-ask spreads (Chang, D'Anna, Watson, & Wee, 2006)
and higher abnormal returns (Agarwal, Liao, Nash, & Tafer, 2008).
 G.E. Iatridis / International Review of Financial Analysis 20 (2011) 88102
Information asymmetry would tend to vary depending on the
rm's growth options and investment strategy. It is uncertain whether
the growth prospects of a rm will eventually yield the expected
returns, or how the use of fair values would impact on the rm's value,
implying that the information asymmetry between rm and stake-
holders would likely be signicant (Smith & Watts, 1982). Higher
information asymmetry and subsequently higher variability in
expected cash ows might result in projects being rejected while
they should be accepted, or being accepted while they should be
rejected. Similar considerations would hold when acquiring a rm
with high growth options, in which case the value of the rm would
be affected by the value of growth options and the inherent infor-
mation asymmetry. Piotroski (2003) and Leuz (2004) have found that
rms with growth opportunities would tend to display lower quality
reporting. In contrast, when a rm disposes of a growth subsidiary or
its investment projects are close to completion, and subsequently its
growth potential becomes lower, information asymmetry would tend
to decrease (LaFond & Watts, 2008).
Therefore, a main issue that arises in nancial reporting is the
information asymmetry that may exist between informed and un-
informed users of accounting information, generally following from
managers' tendency to be reluctant to present losses, while willing to
disclose prots. A conservative presentation of nancial statements
would reduce the scope for earnings manipulation as well as infor-
mation asymmetry, and would in turn lead to higher quality in
nancial reporting (see Ball, 2001; Watts, 2006). Thus, it would be
closely associated with the objectives of efcient corporate gover-
nance as it seeks to minimise the potential for managing earnings and
misleading investors and to increase rm value (LaFond & Watts,
2008). It follows that as information becomes more specic and falls
within certain recognition and presentation criteria, earnings manip-
ulation becomes less feasible. The enhancement of the credibility of
the rm is crucial, especially when it relates to issues, such as equity
issues, mergers and acquisitions (Argenti, Howell, & Beck, 2005;
Brennan & Tamarowski, 2000; Gruner, 2002). Credible and informa-
tive nancial statements would reduce phenomena of miscommuni-
cation between interested parties and would also mitigate users'
scepticism about managers' decisions as well as any agency costs that
reduce the rm's expected cash ows. The existence of agency costs,
which would increase as outside equity increases (Jensen & Meckling,
1976), would motivate stakeholders to instal mechanisms to monitor
managers' behaviour (see Crutchley, Jensen, Jahera, & Raymond,
1999). Such monitoring mechanisms might however be costly and
slow down a rm's nancial progress. On the other hand, it may be
that through increased disclosure, rms seek to inuence or window-
dress their nancial numbers or even mislead investors' attention
(Premuroso, Skantz, Terrance, & Bhattacharya, 2008). The question,
however, is whether and to what extent the stock market sees
through such actions and penalises rms accordingly.
2.2. Financial reporting quality and the rm
The benets of transparency and effective accounting disclosure
would improve company nancial performance, risk management,
internal control systems and stock tradeability, while it would also
enhance company growth, nancial reporting quality and communi-
cation (Ambler & Neely, 2007). The use of effective nancial reporting
procedures would be dependent upon the resulting capital market
benets and agency cost savings and costs of reporting nancially
sensitive information (Bradbury, Dean, & Clarke, 2007; Hayes &
Lundholm, 1996). Informative disclosures are also provided especially
when rms have capital needs and seek to raise money in stock and
debt markets (see Mitchell, Chia, & Loh, 1995; Verrecchia & Weber,
2006). Generally, Lang and Lundholm (1993) have found that rms
would be inclined to disclose high quality accounting information
when their performance is favourable. Graham, Harvey, and Rajgopal
91
(2005) show that rms may produce informative accounting
disclosures to reduce information asymmetry and stock price risk.
However, they argue that rms avoid setting a high disclosure level as
it may be difcult to attain it in future periods.
The quality of a rm's nancial behaviour and nancial reporting
would also depend on the level of information asymmetry (Chang et al.,
2006). Effective nancial reporting implies the continuous provision
of voluntary, up to date and high quality disclosures (Marston, 1996).
The level of accounting disclosure, such as informative annual reports,
earnings forecasts and information on risk exposure, investment
strategy, corporate governance mechanisms, dividend policy, operating
and nancing strategy, etc, would in turn reduce information asymmetry
(Marston, 1996). Periods of uncertainty, such as around the announce-
ment of earnings or the publication of annual reports, may involve
information asymmetry regarding the company's nancial results, -
nancial analysts' future earnings forecasts and other sensitive company
nancial information, which may adversely affect investors' perceptions
and stock liquidity (Kim & Verrecchia, 1994). Firms with effective
nancial reporting would tend to exhibit lower information asymmetry
under such periods of uncertainty and would be rewarded by the stock
market, as they inform investors about the company's nancial and
business strategies and future prospects.
In consistency with agency theory, the assessment of a rm's
nancial reporting quality would assist in the inspection of manage-
rial actions and decisions and would also examine whether managers
act in the best interest of shareholders (Deller, Stubenrath, & Weber,
1999). Effective nancial reporting can essentially inuence market
participants and reduce political and regulatory costs as well as any
potential negative managerial signals (Lev, 1992; Ryder & Regester,
1989). Firms with effective nancial reporting tend to present higher
levels of disclosure, press attention, stock trading volume, institu-
tional ownership and analyst following (Agarwal et al., 2008; Bushee
& Miller, 2007; Lang & Lundholm, 1996, October). Firms with dis-
persed ownership that seek to attract institutional investors would
also tend to provide extensive disclosures in order to disseminate
information to interested parties (Bradbury et al., 2007; Bushee &
Miller, 2007). Bradbury (1991) argues that the cost of accounting
disclosure would depend on the decisions of newcomers in the
market and those of existing market participants. He shows that the
cost of disclosing proprietary information is likely to be higher in
concentrated industries.
Effective nancial reporting would enable rms to strengthen their
presence in the domestic capital markets and enter into foreign
capital markets and thus attract investors internationally. Firms with
effective nancial reporting would tend to experience lower information
asymmetry-related risks and subsequently lower cost of capital, while
their ability to issue capital would appear to be stronger (Agarwal
et al., 2008; Chang et al., 2006). Likewise, Diamond and Verrecchia
(1991) and Brennan and Tamarowski (2000) suggest that the reduction
of information costs and uncertainty can lower the cost of capital and
increase the stock return.
Effective nancial reporting would also reduce the costs of col-
lecting company nancial information that nancial analysts may
face. This would imply that rms with higher nancial reporting
quality would tend to have better analyst coverage and higher stock
trading volume and stock returns (Agarwal et al., 2008). In a similar
vein, Farragher, Kleiman, and Bazaz (1994) argue that rms with high
nancial reporting quality exhibit lower stock information risk and
lower dispersion in analyst forecasts. It is argued that media coverage
may be more essential than analyst coverage, while sometimes rms
tend to improve the quality of accounting disclosure before setting
up their nancial reporting procedures and investor communication
structures (Bushee & Miller, 2007; Falkenstein, 1996; Grullon,
Kanatas, & Weston, 2004).
Enhancing nancial reporting quality appears to be positively
related to rm size, liquidity and exchange listing (see Kadlec &
92 G.E. Iatridis / International Review of Financial Analysis 20 (2011) 88102

McConnell, 1994). This would imply that large and subsequently 2003; Gietzmann & Trombetta, 2003). The hypothesis that is tested
visible rms would be inclined to improve their market picture and is as follows:
information disclosures (Chang et al., 2006). Chang et al. (2006) also
argue that rms with lower liquidity stocks would be motivated to H1. Firms that provide high quality accounting disclosures are likely to
strengthen their nancial reporting quality in order to attract be signicantly different than those that do not.
investors and increase their stock marketability. Small and medium-
To test H1, the study categorises sample rms based on the quality
sized rms that are not listed on a major stock exchange or are less
of their reported accounting disclosures. The study seeks to identify
visible in the market place and struggle to obtain signicant analyst
differences in the nancial measures of rms that provide high quality
following would benet by strong nancial reporting quality and
accounting information and rms that provide low quality accounting
would in turn be able to achieve better market valuations (Agarwal
disclosures and report the minimum required by accounting regula-
et al., 2008; Brennan & Tamarowski, 2000; Hong & Huang, 2005).
tion. This categorisation is based on the examination of rms' nancial
Indeed, Bushee and Miller (2007) report that rms with effective
statements using specic criteria, which are set by the Investor
nancial reporting obtain better market valuations in the year after
Relations Society (IRS) and are detailed in Section 4.2. These criteria
the improvement of their nancial reporting procedures. Also, small
formed a checklist of quality standards, which aimed to overall char-
and newly listed rms would seek to reinforce their nancial
acterise each sample rm as a high or low quality discloser. It must
reporting quality in order to signal that their future nancial per-
be noted that a rm may, for example, display a rich discussion on
formance will improve and therefore impress investors (Hong &
company risk exposure and ample information on KPIs or corporate
Huang, 2005). For example, managers that fail to meet the targeted
responsibility, but it may provide poor quantications of the reported
protability levels might resort to earnings manipulation and to a
non-nancial information. So, the company characterisation gives a
misleading presentation of company nancial performance in order to
general picture of a rm's accounting disclosures and reported in-
avoid providing negative managerial signals (Summers & Sweeney,
formation. Here, the dummy dependent variable used in the logistic
1998). This would be more evident especially when managers have
regression takes 1 for high quality information providers and 0 for low
signicant personal interests vested in the rm. Similar considera-
quality information providers.
tions would also hold for rms that underperform or exhibit negative
Based on the categorisation presented above, i.e. presentation of
market returns (Premuroso et al., 2008).
high/low quality disclosures, the study implements a logit model
Financial reporting quality can be improved by increasing quan-
whereby the explanatory variables are strictly accounting (see
tity, quality and timeliness of information disclosed in earnings an-
Eq. (1)), followed by a logit model, based on Bushee and Miller
nouncements, annual report, press releases and company website.
(2007), whereby the explanatory variables are a mixture of general
Financial reporting quality can also be reinforced by keeping the press
rm-specic nancial attributes (see Eq. (2)). The study focuses on
continuously informed about the company's nancial performance,
the period 2005 to 2009. The logit models used in the study are
prospects and decisions, and by providing explanations about policies
presented below:
adopted by management and information about the company's
operating, investing and nancing activities (Chang et al., 2006).
AQ i;t = a0 + a1 ROAi;t + a2 MVBVi;t + a3 TLSFUi;t + a4 OCFi;t 1
Mediratta and Jain (2007) have found that rms generally tend to
report sufcient information on their business and strategies as well + a5 LNAi;t + a6 ECNi;t + a7 DCNi;t + a8 i;t + ei;t
as on their current performance, while they experience difculties
where
when preparing information about their future nancial prospects
and off-balance sheet items.
AQ i,t is a dummy variable representing the quality of reported
accounting information. AQ i,t = 1 for rms reporting high
quality accounting information and AQ i,t = 0 otherwise,
3. Research hypotheses
ROAi,t is net income before extraordinary items scaled by total
assets,
3.1. High quality accounting disclosures
MVBVi,t is market value scaled by book value,
TLSFUi,t is total liabilities scaled by shareholders' funds,
The study focuses on the identication of the motives for the
OCFi,t is operating cash ows scaled by total assets,
provision of high quality accounting disclosures. While providing
LNAi,t is the log of total assets,
comprehensive accounting disclosures, rms provide evidence and
ECNi,t is a dummy variable indicating company equity capital
assurance that their actions are consistent with the law and ac-
needs. ECNi,t = 1 for rms with equity capital needs and
counting regulation and in line with investors' expectations and
ECNi,t = 0 otherwise,
interests (Zimmerman, 1983). Such assurance would lead to lower
DCNi,t is a dummy variable indicating company debt capital needs.
political, agency and regulatory costs. The considerations above
DCNi,t = 1 for rms with debt capital needs and DCNi,t = 0
would hold especially for large rms, which are subject to political
otherwise,
attention and scrutiny to a greater degree than smaller rms (see
i,t is the change in net income before extraordinary items,
Ali & Kumar, 1994; Moses, 1987; Ndubizu & Tsetsekos, 1992).
ei,t is the error term.
Firms that are not performing well are not likely to provide rich
accounting disclosures. In contrast, rms that perform well would
be inclined to disclose detailed and sensitive accounting informa- AQ i;t = a0 + a1 TVi;t + a2 PCi;t + a3 MCi;t + a4 Di;t + a5 SHi;t 2
tion in order to provide evidence of superior managerial ability. + a6 AUi;t + a7 Ii;t + ei;t
Firms would tend to disclose higher quality information in periods
of large negative earnings news, or when they seek to reduce stock where
return risk (Bens, 2002; Kasznik & Lev, 1995). Also, rms that seek
to raise capital in stock and debt markets would be expected to AQ i,t is a dummy variable representing the quality of reported
provide market participants with informative accounting disclo- accounting information. AQ i,t = 1 for rms reporting high
sures in order to give evidence of higher quality nancial reporting, quality accounting information and AQ i,t = 0 otherwise,
lower the cost of capital and improve the terms and the prospects TVi,t is the share trading volume scaled by shares outstanding,
of the capital issue (Bushman & Smith, 2001; Errunza & Miller, PCi,t is the log of the number of pages in the annual report,
 G.E. Iatridis / International Review of Financial Analysis 20 (2011) 88102
MCi,t is a dummy variable that proxies for changes in the man-
agement. MCi,t = 1 when changes in the management have
occurred in the year and MCi,t = 0 otherwise,
Di,t is the number of days with a non-zero volume in the period
scaled by the total number of trading days (see Bushee &
Miller, 2007),
SHi,t is the log of the number of outstanding shares,
AUi,t is a dummy variable that proxies for auditing. AUi,t = 1
when a rm is audited by a Big-4 auditor and AUi,t = 0
otherwise,
Ii,t is a dummy variable to control for industry,
ei,t is the error term.
3.2. Discretionary accruals and high quality accounting disclosures
High quality accounting disclosures would provide interested
parties with signicant accounting information relating to managerial
behaviour, actions and decision-making, company strengths and weak-
nesses, and would assist users in making forwarding-looking company
assessment and investment decisions. Therefore, the provision of high
quality disclosures and the subsequent investor awareness would tend
to reduce the potential for earnings management. The hypothesis that
is tested is as follows:
H2. Firms that provide high quality accounting disclosures are likely to
exhibit lower discretionary accruals.
The study focuses on the period 2005 to 2009 and uses an Ordinary
Least Square (OLS) regression to determine the association between
discretionary accruals and cash ows as well as protability, leverage
and size. The regression model that is used is as follows (see Tendeloo
& Vanstraelen, 2005):
DACi;t = a0 + a1 AQ i;t + a2 AQi;t x OCFi;t + a3 AQi;t x LNAi;t
+ a4 AQ i;t x ROAi;t + a5 AQ i;t x TLSFUi;t + ei;t
where
DACi,t is the discretionary accruals that are estimated using the
cross-sectional Jones model (Jones, 1991). The study uses
the residuals of the following regression model as discre-
tionary accruals (see also DeFond and Subramanyam, 1998;
Bartov, Gul, & Tsui, 2001; Kothari, Leone, & Wasley, 2004;
Garza-Gomez, Lee, & Du, 2006).
 
ACi;t = a0 1 = Ai;t1 + a1 REVi;t + a2 PPEi;t + ei;t
where
ACi,t is accruals in year t scaled by lagged total assets, i.e. total
assets in year t 1. Accruals equal the annual change in
current assets (excluding cash) minus current liabilities
(excluding short-term debt and income tax payable) minus
depreciation,
Ai,t-1 is total assets in year t 1,
REVi,t is the annual change in revenues in year t scaled by lagged
total assets,
PPEi,t is property, plant and equipment in year t scaled by lagged
total assets,
ei,t is the error term.
All other variables are dened as in Eq. (1).
The second test examines rms' aptitude to manage accounting
numbers in order to report, for example, small prots rather than
93
losses (Burgstahler and Dichev, 1997; Leuz, Nanda, & Wysocki, 2003).
The study also examines the speed by which losses are recognised, in
the sense that the timely recognition of large losses should provide
evidence of lower earnings management (Lang, Raedy, & Wilson,
2005). Within the independent variables, the study uses a dummy
variable, SP, as a measure of small prots (see Lang, Lins, & Miller,
2003; Barth, Landsman, & Lang, 2008), and a dummy variable, LL, as a
measure of timely loss recognition (see Lang et al., 2003, 2005). The
logit model takes the following form:
AQ i;t = a0 + a1 ROAi;t + a2 MVBVi;t + a3 TLSFUi;t + a4 OCFi;t 5
+ a5 LNAi;t + a6 SPi;t + a7 LLi;t + ei;t
where
SPi,t is a dummy variable indicating a measure of small prots.
SPi,t = 1 if net prot scaled by total assets is between 0 and
0.01 and SPi,t = 0 otherwise,
LLi,t is a dummy variable indicating a measure of timely loss
recognition. LLi,t = 1 if net prot scaled by total assets is less
than 0.20 and LLi,t = 0 otherwise. All other variables are
dened as in Eq. (1).
A negative coefcient for SPi,t would show that rms reporting
high quality accounting information tend to manage their prot
gures, in order to report small positive rather than negative amounts,
less frequently. A positive coefcient for LLi,t would suggest that rms
reporting high quality accounting information tend to recognise large
losses more readily.
3.3. Conservatism and high quality accounting disclosures
Conservatism is dened as the accountant's tendency to require
3
a higher degree of verication to recognise good news as prots than
to recognise bad news as losses (Basu, 1997, p. 7). The accounting
literature identies two types of accounting conservatism. The con-
ditional conservatism is described as the higher degree of verication
that is required when good news is reported (Basu, 1997). Un-
conditional conservatism relates to the early recognition of losses
regardless of whether the news is good or bad (Qiang, 2007).
Managers may be opportunistically motivated to overstate assets
and earnings related gures and understate liabilities in order to
improve their bonuses and wealth or the company nancial prole
and future nancial prospects. Conservatism would tend to under-
state assets and earnings and offset managers' opportunistic behav-
iour (Watts, 2003). However, unconditional conservatism may arise
4
from tax, litigation and managerial self-interest (Cano-Rodrguez,
2010, p. 132), and it may subsequently lower the information value
of reported nancial information (Ball, Robin, & Sadka, 2008). For
example, unconditional conservatism may be related to the imple-
mentation of depreciation or stock valuation methods that serve
certain managerial and opportunistic goals. It follows, therefore, that
unconditional conservatism may introduce noise in the nancial
reports and lead to biassed and inefcient economic decisions (Ball &
Shivakumar, 2005). Unconditional conservatism may be desirable in
order to obtain better terms of nancing, to meet earnings targets, or
to hide adverse movements in rm nancial numbers or economically
bad decisions (Burgstahler, Hail, & Leuz, 2006; Coppens & Peek, 2005).
Cano-Rodrguez (2010) has found that unconditional conservatism is
present in the case of rms with large size, high leverage and low
growth, and particularly rms that are close to nancial distress and
experience high litigation risk and low reputation levels.
Only conditional conservatism can improve contracting efciency
as it relates to disclosures of difcult-to-verify accounting information
(Basu, 2005). It follows, therefore, that rms with higher contracting
94 G.E. Iatridis / International Review of Financial Analysis 20 (2011) 88102
costs would incorporate conditional conservatism in their nancial
reporting process as opposed to unconditional conservatism (Qiang,
2007). For example, conditional conservatism arises in the case of
goodwill impairment, when the respective assets are carried at more
than their recoverable amount (IAS 36 Impairment of Assets). Thus,
conditional conservatism reinforces the value relevance and informa-
tion usefulness of reported accounting numbers. Hence, conditional
conservatism is desired by shareholders, lenders and other stake-
holders, because it would give them a clear view of the rm's strengths
and weaknesses and assist them in making correct judgment and
investment choices (see Guay & Verrecchia, 2007). Conditional con-
servatism would subsequently be evident especially when high quality
accounting information is required, such as in the case of issuing equity
and debt capital, cross-listing, or when strong investor protection
mechanisms are in place, such as in common-law countries (Ball,
Kothari, & Robin, 2000; Bushman & Piotroski, 2006; Francis & Wang,
2008).
It follows therefore that conditional and unconditional conserva-
tism cannot be regarded as substitutes (Basu, 2005). In contrast, they
may be negatively related (Qiang, 2007; Vander Bauwhede, 2007).
Unconditional conservatism anticipates future bad news and may be
applied in a manner so as to meet the rm's managerial objectives
before the event, obstructing the use of conditional conservatism after
the event, i.e. after the realisation of the anticipated bad news (Beaver
& Ryan, 2005). The study predicts that earnings of rms that prepare
high quality annual reports would be more conservative than
earnings of rms that present low quality annual reports.1 The period
under investigation is 2005 to 2009. The hypothesis and the OLS
model are based on Cano-Rodrguez (2010, p. 141) and are as follows:
H3. Firms that report high quality accounting disclosures are likely to
display higher conditional conservatism and lower unconditional
conservatism compared to low quality accounting disclosers.
DACi;t = a0 + a1 CFDi;t + a2 OCFi;t + a3 CFDi;t x OCFi;t + a4 AQi;t
+ a5 AQ i;t x CFDi;t + a6 AQ i;t x OCFi;t +a7 AQ i;t x CFDi;t xOCFi;t + ei;t
6
where
DACi,t is the discretionary accruals dened as in Eq. (3),
CFDi,t is a dummy variable representing the sign of operating cash
ows. CFDi,t = 1 if operating cash ows scaled by total assets
is negative and CFDi,t = 0 otherwise,
OCFi,t is operating cash ows scaled by total assets,
AQi,t is a dummy variable representing the quality of reported
accounting information. AQi,t = 1 for rms reporting high
quality accounting information and AQi,t = 0 otherwise,
ei,t is the error term.
The relation between nancial reporting quality, as expressed by
the quality of accounting disclosures, and conditional conservatism is
captured with a7. A signicantly positive a7 would signify that rms
that provide high quality accounting disclosures display signicantly
greater conditional conservatism compared to rms that provide low
quality accounting disclosures. In other words, in the presence of
conditional conservatism, a rm that reports high quality accounting
information would be expected to exhibit low discretionary accruals
even if it experienced negative or low cash ows.
1
In the absence of strong investor protection mechanisms and effective market
rules, company insiders might take advantage of the information asymmetry that
would stem from poor accounting disclosures to make abnormal prots to the
detriment of investors (Ball et al., 2000). Therefore, future research should examine
the motives for (non-) application of conservative nancial reporting under different
levels of stock market efciency and regulatory effectiveness.
To capture the relation between nancial reporting quality and un-
conditional conservatism, the study employs the variable UC AQ =1=
4 +
5 xNOCF AQ = 1 used in Cano-Rodrguez (2010, p. 141). 4
and 5 are the estimates of 4 and 5 presented in Eq. (6). NOCF
(AQ = 1) is the proportion of rms that display high accounting quality
and negative cash ows. Cano-Rodrguez (2010) argues that following
that unconditional conservatism is news-independent only conditional
conservatism provides new information, which essentially is the
difcult-to-verify accounting information UC (AQ = 1) would seek to
focus on the accruals that are independent of good or bad news among
high and low accounting quality disclosers (see also Beaver & Ryan,
2005; Vander Bauwhede, 2007). UC (AQ = 1) is inversely related to
unconditional conservatism, implying that a positive value would show
that rms that provide high quality accounting disclosures are associated
with lower unconditional conservatism.
3.3.1. The relation between conditional and unconditional conservatism
Following the discussion on conditional and unconditional con-
servatism and their inverse relation set out in the previous section,
the study tests the association of the two types of conservatism in
the light of high and low quality accounting disclosures. As described
above, conditional conservatism would be expected to be inversely
related to unconditional conservatism (see Qiang, 2007; Vander
Bauwhede, 2007). The hypothesis that is tested is as follows:
H4. For high quality accounting disclosers, conditional conservatism is
negatively related to unconditional conservatism.
The study focuses on the period 2005 to 2009 and employs the OLS
models used in Cano-Rodrguez (2010, p. 153) as follows:
Rank UCi;t = 0 + 1 AQPi;t + 2 Ai;t + 3 TLSFUi;t + 4 VBVi;t + ei;t
7
Rank CCi;t = 0 + a1 Rank UCi;t + a2 AQPi;t + 3 Ai;t 8
+ 4 TLSFUi;t + 5 VBVi;t + ei;t
where
Rank UCi,t accounts for unconditional conservatism and is the rank
0 +
of UCi,t computed as 1 x NOCF, with
0 and
1 being
the estimates of 0 and 1 of Eq. (9). NOCF is the proportion
of rms that display high accounting quality and negative
cash ows.
DACi;t = a0 + a1 CFDi;t + a2 OCFi;t + a3 CFDi;t x OCFi;t + ei;t 9
All variables in Eq. (9) are dened as in Eq. (6).
Rank CCi,t accounts for conditional conservatism and is the rank of 3
obtained from Eq. (9),
AQPi,t is the proportion of rms that report high quality account-
ing disclosures,
Ai,t is the average of the log of total assets,
TLSFUi,t is the average of total liabilities scaled by shareholders'
funds,
MVBVi,t is the average of the ratio of market value to book value,
ei,t is the error term.
3.3.2. Earnings sensitivity and conservatism
Following the discussion about conditional and unconditional con-
servatism in Sections 3.3 and 3.3.1, here the study examines earnings
sensitivity and conservatism of high and low quality accounting
 G.E. Iatridis / International Review of Financial Analysis 20 (2011) 88102
disclosers. This section seeks to test the relation between earnings
conservatism and reporting quality, i.e. whether in the light of high
quality accounting disclosures, less prots and/or more losses are
reected in company nancial statements. To this end, the study uses
the following OLS model that is based on Ball et al. (2000) and LaFond
and Watts (2008) and is applied for the positive and negative return
samples separately. The period under investigation is 2005 to 2009.
NIi;t = a0 + a1 Ri;t + a2 AQ i;t + a3 AQ i;t x Ri;t + ei;t
where
NIi,t is net income before extraordinary items scaled by begin-
ning of scal year market value of equity,
Ri,t is the annual stock return,
AQ i,t is a dummy variable representing the quality of reported
accounting information. AQi,t = 1 for rms reporting high
quality accounting information and AQi,t = 0 otherwise,
ei,t is the error term.
The study anticipates that a3 will be signicantly negative for rms
that bear good news, and positive for rms that exhibit bad news.
Subsequently, the study uses the OLS model below that combines the
positive and negative return samples (see LaFond & Watts, 2008).
NIi;t = a0 + a1 NDRi;t + a2 Ri;t + a3 Ri;t x NDRi;t + a4 AQ i;t
+ a5 NDRi;t x AQi;t +a6 AQ i;t x Ri;t + a7 Ri;t x NDRi;t x AQ i;t +ei;t
where
NDRi,t is a dummy variable that proxies for bad news. NDRi,t = 1 for
negative returns and NDRi,t = 0 otherwise. All other vari-
ables are dened as in Eq. (10).
The study predicts that a7 will be signicantly positive, implying
that higher quality in accounting disclosures would lead to higher
asymmetry in the recognition of prots and losses in annual reports,
i.e. greater conservatism.
The study also uses the following OLS model to control for growth
and leverage that inuence conservatism based on Fama and MacBeth
(1973) and LaFond and Watts (2008).
NIi;t = a0 + a1 NDRi;t + a2 Ri;t + a3 Ri;t x NDRi;t + a4 MVBVi;t
+ a5 MVBVi;t x NDRi;t + a6 MVBVi;t x Ri;t + a7 MVBVi;t x Ri;t x NDRi;t
+ a8 TLSFUi;t + a9 TLSFUi;t x NDRi;t + a10 TLSFUi;t x Ri;t
+ a11 TLSFUi;t x Ri;t x NDRi;t + a12 AQ i;t + a13 AQ i;t x NDRi;t
+ a14 AQ i;t x Ri;t + a15 AQ i;t x Ri;t x NDRi;t + ei;t
All variables are dened as in Eqs. (1), (10) and (11).
Roychowdhury and Watts (2007) and LaFond and Watts (2008)
argue that rms with high growth options (MVBV) would tend to
display higher information asymmetry between management and
investors and therefore exhibit lower conservatism (Smith and Watts,
1982). They also indicate that leverage (TLSFU) and accounting quality
(AQ) would display a positive association with conservatism. Watts
(1993 and 2006) shows that debt contracting inuences conservatism
signicantly, since debt capital providers would require conservatism as
a means of enhancing accounting quality and the reliability of reported
numbers, and assessing rms' future nancial potential. Hence, earnings
conservatism would be expected to improve the terms of borrowing and
reduce agency costs.
95
4. Data and company categorisation
4.1. Datasets and empirical methods
The empirical analysis concentrates on the period after the adoption
of the International Financial Reporting Standards (IFRS), i.e. 2005 to
2009. The sample consists of 500 UK rms. All sample rms are IFRS
users. The study has found that 120 sample rms provided high quality
10 accounting disclosures in 2005, 145 rms in 2006, 165 rms in 2007,
180 rms in 2008 and 193 rms in 2009. Accounting and nancial data
were collected from DataStream. Information about the accounting
policies of the sample rms was obtained from their published annual
reports. Annual report collectability has rounded the sample size down
to 500 rms. All sample rms are listed on the London Stock Exchange.
The analysis has excluded banks, insurance, pension and brokerage
rms, as their accounting measures are not always comparable with
those of industrial rms. The research hypotheses are tested using the
binary logistic regression analysis and the OLS regression analysis.
The logistic regression is useful in analysing categorical data, where
the dependent variable is dichotomous and takes only two values,
i.e. 0 and 1. The parameters of the logistic regression are estimated
based on the maximum likelihood method, while the hypothesis
testing is based on the Wald statistic. The diagnostic tests entailed an
assessment of: (i) the relative signicance of the estimated coefcients
(p-value b 0.01; two-tailed); (ii) the magnitudes of the logit models'
studentised residuals (b3.0); and (iii) the naive proportional chance
11 model (see Joy & Tollefson, 1975). All the logistic regression results
reported in this study have consistently passed those tests.
The study has accounted for heteroscedasticity, autocorrelation,
departure from normality and multicollinearity, where appropriate.
The tests that have been performed to check the OLS assumptions are
the White test and the Autoregressive Conditional Heteroscedasticity
(ARCH) test for heteroscedasticity; the DurbinWatson test and the
BreuschGodfrey test for autocorrelation; the JarqueBera test for the
departure from normality of residuals; and the correlation coefcients
among the test variables for multicollinearity.
The study is limited in the sense that it focuses on a common-law
country with strong investor protection mechanisms and investor-
oriented nancial reporting (Tendeloo & Vanstraelen, 2005), which
would be likely to facilitate conservatism to a greater extent than
other settings, such as code-law countries. Hence, future research
should examine the use of conditional and unconditional conserva-
tism in code-law countries, which, unlike common-law countries,
would tend to call for less public disclosure, encouraging therefore
phenomena of opportunism (Leuz et al., 2003). Also, while the study
has focused on the period after the adoption of IFRSs, i.e. 2005, the
examination of a larger period encompassing the transition from UK
GAAP to IFRSs would be in position to describe the evolution of con-
12
servatism under different accounting rules or institutional character-
istics. Future research should investigate which items of accounting
information are veriable, to what extent they are veriable and
how easily and objectively. For example, Watts (2006) has found
that only a limited set of future cash ow items, such as accounts
receivable, may be adequately and satisfactorily veriable and useful
to investors.
4.2. Annual report classication
Due to the various elements that accounting disclosures encom-
pass, it is difcult to build a single measure to evaluate the quality of
reported accounting information. Like Geerings, Bollen, and Hassink
(2003), who examined corporate websites to evaluate companies'
investor relations schemes, this study examines companies' annual
reports by using a checklist to rate the quality of reported accounting
information. IRS issues best report guidelines to assist rms in the
preparation of higher quality annual reports. The guidelines issued by
96 G.E. Iatridis / International Review of Financial Analysis 20 (2011) 88102

IRS have formed the basis for formulating the checklist used in the Table 1
study. The examination of companies' annual reports based on the Descriptive statistics.

IRS checklist sought to distinguish the sample companies into high Panel A high quality disclosers Panel B low quality disclosers
and low quality information providers. As used in the study, the IRS
Variables Mean Std deviation Mean Std deviation
checklist contains the following items (see http://www.ir-soc.org.uk).
MVBV 2.326 2.414 2.802 3.061
a) Communication of strategy and KPIs: understandable presenta- TLSFU 2.391 3.033 1.509 1.360
LNA 3.288 1.703 2.785 1.640
tion of the company's business; efcient implementation of key 0.786 0.392 0.805 0.562
performance indicators, including nancial and non-nancial mea- R 0.312 0.571 0.119 1.024
sures; disclosure and analysis of qualitative and quantitative TV 3.376 1.031 2.961 1.044
evidences; discussion of positive and negative developments; ex- PC 0.285 0.452 0.030 0.171
MC 0.179 0.084 0.125 0.101
planation of nancial and business trends and prospects; provision
AU 0.220 0.116 0.175 0.138
of information on operational performance at group and segment DAC 0.148 0.197 0.091 0.234
level. SP 0.117 0.183 0.280 0.249
b) Communication of governance and risk: compliance with the LL 0.025 0.157 0.006 0.079
combined code of corporate governance; discussion of the reasons OCF 0.033 0.091 0.024 0.071
NI 2.306 2.959 1.899 2.161
of non-compliance or deviation from the provisions of the com-
bined code; disclosure of the company directors' remuneration The sample period is 2005 to 2009. The study reports that 120 sample rms provided
high quality accounting disclosures in 2005, 145 rms in 2006, 165 rms in 2007, 180
policy; presentation of the company's communication with share-
rms in 2008 and 193 rms in 2009. MVBV is market value scaled by book value. TLSFU
holders; discussion of risks and how they are managed; explana- is total liabilities scaled by shareholders' funds. LNA is the log of total assets. is the
tion of how risks are identied and monitored. change in net income before extraordinary items. R is the annual stock return. TV is the
c) Communication of corporate responsibility: how corporate respon- share trading volume scaled by shares outstanding. PC is the log of the number of pages
in the annual report. MC is a dummy variable that takes 1 when changes in the
sibility objectives are met; provision of information on corporate
management have occurred in the year and 0 otherwise. AU is a dummy variable that
responsibility monitoring and evaluation process; and honest takes 1 when a rm is audited by a Big-4 auditor and 0 otherwise. DAC is the
description of weaknesses, uncertainties or failures. discretionary accruals that are estimated using the cross-sectional Jones model. SP is a
d) Presentation and effectiveness of annual report: layout and struc- dummy variable that takes 1 if net prot scaled by total assets is between 0 and 0.01 and
ture (e.g. target audience, key messages, etc); simplicity, clarity 0 otherwise. LL is a dummy variable that takes 1 if net prot scaled by total assets is less
than 0.20 and 0 otherwise. OCF is operating cash ows scaled by total assets. NI is net
and consistency; understandability of quantitative data; key area
income before extraordinary items scaled by the beginning of scal year market value
coverage (e.g. nancial results, segmental analysis, directors' of equity.
remuneration, and corporate responsibility); usability and func-
tionality in meeting user needs; and feedback from users as to
how to improve the content and style of reported accounting reect and/or reinforce the potential for earnings management. In
information. addition, high quality accounting disclosers exhibit a less positive
e) Analysis of nancial position (see Ambler & Neely, 2007): pre- mean value for small positive earnings (SP) and a more positive mean
sentation of accounting policies; disclosure of short and long-term value for large losses (LL) than low quality accounting disclosers,
capital structure; analysis of cash ows; liquidity (e.g. working implying that the former would report small positive earnings less
capital and borrowing requirements); and protability (e.g. sales frequently and would recognise large losses more timely. The de-
volume and prot ratios). scriptive statistics also show that high quality accounting disclosers
display higher page count (PC) in their annual reports, and are more
5. Empirical ndings likely to be audited by a Big-4 auditor (AU) and to exhibit a change in
their management (MC).
5.1. Descriptive statistics

Table 1 presents the descriptive statistics for the sample rms
examined in the study. Panel A displays the means and standard
deviations for high quality accounting disclosers, while Panel B for low
quality accounting disclosers. The descriptive statistics show that
rms that disclose accounting information of lower quality exhibit
higher growth (MVBV). High quality accounting disclosers display
higher size (LNA) and share turnover (TV), indicating that they are
visible in the market, while they also exhibit higher level of debt
(TLSFU). Firms that prepare high quality nancial statements are
more protable (NI) and show higher changes in net income () and
stock returns (R). It is noteworthy that the standard deviation of stock
returns that is observed for low quality accounting disclosers is 1.024,
as opposed to 0.571 for high quality accounting disclosers, reecting
a higher probability of reporting negative returns. High quality
accounting disclosers also display a higher mean value for operating
cash ows (OCF). Table 1 indicates that the discretionary accruals
(DAC) of high quality accounting disclosers carry a negative mean
(0.148) as opposed to the positive mean value (0.091) that is
obtained for low quality accounting disclosers. This nding signies
that the disclosure of high quality accounting information would
discourage the implementation of earnings management practises
and would encourage conservatism. In contrast, the presentation of
low quality accounting disclosures in nancial statements is likely to
5.2. High quality accounting disclosures
Panel A of Table 2 shows that H1 holds, implying that rms that
display high quality reported information are signicantly different
compared to those that do not. High quality information providers are
visible in the stock market, as they exhibit higher size (LNA) and
therefore their nancial decisions and actions are monitored by
nancial analysts, investors and stock market authorities. Their higher
return on assets (ROA) and cash ow ratio (OCF) would encourage
and motivate high quality information providers to prepare and
publish high quality accounting disclosures to ensure that stock
market participants become aware of their favourable nancial mea-
sures. Higher protability and liquidity and high quality disclosures
would be expected to be linked as the latter might be considered to
be a reasonable path for rms with higher protability. The opposite,
i.e. rms with lower protability or liquidity providing high quality
disclosures, would tend to have higher informational and research
value.
The study has also found that debt and equity capital dependence
would make rms disclose accounting information of higher quality.
Panel A shows that high quality disclosers tend to exhibit higher
equity (ECN) and debt (DCN) capital needs and leverage (TLSFU).
This would signify that high quality accounting disclosures would
 G.E. Iatridis / International Review of Financial Analysis 20 (2011) 88102 97

Table 2 to report information of value to investors to obtain their condence,

High quality accounting disclosures. ease of access to capital markets, and show their superiority as op-
Panel A logistic regression Panel B logistic regression posed to their predecessors. Firms that are audited by a Big-4 auditor
would have higher quality guidance on preparing their accounts,
Accounting variables Firm-specic nancial variables
while they should also be inclined to provide informative accounting
Variables Coefcients Variables Coefcients
disclosures in order to obtain a favourable (Big-4) audit report.
ROA 1.135*** TV 0.0001*** Accounts that are audited rigorously would be expected to be less
(0.356) (0.0001)
misleading and less prone to error, and would therefore reect higher
MVBV 0.322* SH 0.402***
(0.180) (0.107)
credibility and reliability (Bushman & Smith, 2001). Indeed, Panel B
LNA 0.257*** MC 2.191* shows that high quality disclosers tend to be audited by a Big-4
(0.070) (1.252) auditor (AU).
OCF 0.169*** D 0.338**
(0.055) (0.166)
5.3. Discretionary accruals and high quality accounting disclosures
TLSFU 0.040** AU 0.643***
(0.019) (0.242)
ECN 0.911*** Constant 0.795 Table 3 provides evidence that H2 holds, implying that rms that
(0.365) (0.584) provide high quality accounting disclosures are likely to exhibit lower
DCN 1.053*** discretionary accruals. Panel A shows that AQ carries a signicantly
(0.169)
Constant 1.525
negative coefcient, suggesting that rms that report high quality
(0.277) accounting information exhibit lower discretionary accruals and
therefore are likely to be less prone to earnings management. Panel
Model 2 33.471*** Model 2 28.398* A also shows that AQOCF and AQROA are signicantly positive,
% Correctly classied 65.9 % Correctly classied 57.1
implying that rms with high quality accounting disclosures and, say,
Sample size = 2500 Sample size = 2500
low operating cash ows (OCF) and return on assets (ROA) would
***, ** and * indicate statistical signicance at the 1%, 5% and 10% level (two-tailed)
display low discretionary accruals. Likewise, rms with high quality
respectively. All the explanatory variables were entered/removed from the logistic
regressions using a step-wise procedure with a p-value of 0.05 to enter and a p-value of
nancial reporting carry a signicantly negative coefcient for
0.10 to remove. The Wald statistic was used to test the null hypothesis that each AQTLSFU and AQLNA, indicating that rms with high total liabilities
coefcient is zero. The sample period is 2005 to 2009. ROA is net income before to shareholders' funds (TLSFU) and size (LNA) would engage less in
extraordinary items scaled by total assets. MVBV is market value scaled by book value. earnings management.
LNA is the log of total assets. OCF is operating cash ows scaled by total assets. TLSFU is
Panel B examines whether rms manage their accounting num-
total liabilities scaled by shareholders' funds. ECN is a dummy variable that takes 1
when a rm has equity capital needs and 0 otherwise. DCN is a dummy variable that bers to report small prots rather than losses, and also assesses the
takes 1 when a rm has debt capital needs and 0 otherwise. TV is the share trading timely recognition of large losses in the income statement as a
volume scaled by shares outstanding. SH is the log of the number of outstanding shares. measure of earnings management. The ndings show that rms that
MC is a dummy variable that takes 1 when changes in the management have occurred
provide high quality accounting disclosures display higher return on
in the year and 0 otherwise. D is the number of days with a non-zero volume in the
period scaled by the total number of trading days. AU is a dummy variable that takes 1
assets (ROA) and cash ow ratio (OCF) as reported in Table 2. Firms
when a rm is audited by a Big-4 auditor and 0 otherwise. that disclose high quality accounting information carry a signicantly

Table 3
reinforce the validity and reliability of the reported accounting Discretionary accruals and high quality accounting disclosures.
information and would also provide capital providers with safety
and lower uncertainty. The considerations set out above would Panel A OLS regression Panel B logistic regression

therefore enable rms to obtain equity and debt nancing on better Discretionary accruals on rm Small prots and large losses
terms and positively inuence the capital issue. In contrast, rms that nancial measures

experience higher growth (MVBV) appear to report lower quality Variables Coefcients Variables Coefcients
accounting disclosures perhaps to conceal unfavourable performance AQ 0.010*** SP 0.430**
measures, avoid disappointing capital providers, and facilitate their (0.003) (0.203)
growth process. AQ ROA 0.172*** ROA 0.202***
Panel B of Table 2 shows that rms that disclose high quality (0.054) (0.051)
AQ TLSFU 0.211*** LL 0.615***
accounting information tend to display higher share trading volume (0.064) (0.230)
(TV). This shows that the provision of informative and high value AQ OCF 0.036* OCF 0.014**
accounting disclosures attracts investors' attention as reected by the (0.019) (0.006)
higher trading volume. It may also be that rms disclose high quality AQ LNA 0.001*** Constant 0.576
(0.0001) (0.228)
accounting information because investors and other stock market
Constant 0.044
participants watch their decisions and actions.2 This is also evidenced (0.062)
by the higher number of days with a non-zero volume in the period
(D), which expresses investors' interest in and appreciation of high Model 2 33.461***
quality disclosers' shares (see Bushee & Miller, 2007). The higher log R2 adj. 0.026 % Correctly classied 58.7
Sample size = 2500 Sample size = 2500
of number of outstanding shares (SH) shows that the large part of
rm ownership that belongs to outsiders, and potentially the large ***, ** and * indicate statistical signicance at the 1%, 5% and 10% level (two-tailed)
respectively. All the explanatory variables were entered into/removed from the logistic
investor information needs, would make rms to report higher quality
regression in Panel B using a step-wise procedure with a p-value of 0.05 to enter and a
accounting disclosures. High quality disclosers experience a change in p-value of 0.10 to remove. The Wald statistic was used to test the null hypothesis that
management (MC), indicating that the new management seeks each coefcient is zero. The sample period is 2005 to 2009. AQ is a dummy variable that
takes 1 for rms reporting high quality accounting information and 0 otherwise. ROA is
net income before extraordinary items scaled by total assets. TLSFU is total liabilities
scaled by shareholders' funds. OCF is operating cash ows scaled by total assets. LNA is
2
Future research should use information on analyst following to assert this the log of total assets. SP is a dummy variable that takes 1 if net prot scaled by total
argument and examine whether investors' perceptions and expectations can be a assets is between 0 and 0.01 and 0 otherwise. LL is a dummy variable that takes 1 if net
driving force for providing accounting disclosures of higher quality. prot scaled by total assets is less than 0.20 and 0 otherwise.
98 G.E. Iatridis / International Review of Financial Analysis 20 (2011) 88102

negative coefcient for SP, suggesting that they report small positive Table 5
earnings less frequently. They also carry a signicantly positive co- Relation between conditional and unconditional conservatism.

efcient for LL, implying that they tend to recognise large losses more Panel A OLS regression Panel B OLS regression
timely. Therefore, it follows that rms that provide accounting
Unconditional conservatism Conditional conservatism
disclosures of lesser quality would tend to smooth their earnings by
Variables Coefcients Variables Coefcients
delaying the recognition of large losses.
Rank UC 0.553*
(0.323)
5.4. Conservatism and high quality accounting disclosures AQP 0.975*** AQP 0.067***
(0.091) (0.020)
Table 4 reports the ndings obtained from Eq. (6) regarding the A 0.100 A 0.005
relation between conditional and unconditional conservatism and (0.105) (0.009)
TLSFU 0.120** TLSFU 0.004**
accounting quality. Consistent with H3, a7 that captures the associa-
(0.059) (0.002)
tion between nancial reporting quality and conditional conservatism MVBV 0.284 MVBV 0.076
is signicantly positive, showing that rms that report high quality (0.223) (0.061)
accounting disclosures display higher conditional conservatism. This Constant 0.203 Constant 0.126
nding suggests that high quality nancial reporting would reinforce (0.259) (0.087)
R2 adj. 0.35 R2 adj. 0.28
the contracting efciency and validity of reported nancial numbers,
thereby increasing conditional conservatism. Here, the study employs ***, ** and * indicate statistical signicance at the 1%, 5% and 10% levels (two-tailed)
respectively. The sample period is 2005 to 2009. AQP is the proportion of rms that
an alternative measure of conditional conservatism, i.e. a6 + a7, which
report high quality accounting disclosures. A is the average of the log of total assets.
is the non-incremental reaction of accruals to negative cash ows TLSFU is the average of total liabilities scaled by shareholders' funds. MVBV is the
based on Cano-Rodrguez (2010, p. 146). a6 + a7 amounts to a positive average of the ratio of market value to book value. Rank UC accounts for unconditional
gure that is insignicantly different to a7. The coefcient obtained for conservatism and is the rank of UC computed as 0 + 1 x NOCF, with
0 and
1 being
UC (AQ = 1), which captures the relation between accounting quality the estimates of 0 and 1 of Eq. (9). NOCF is the proportion of rms that display high
accounting quality and negative cash ows. UC is inversely related to unconditional
and unconditional conservatism, is signicantly positive. The positive conservatism.
coefcient would indicate that the portion of accruals that are
independent of good or bad news is larger for high accounting quality
disclosers. Hence, following that UC (AQ = 1) is inversely related to the coefcient obtained for QP is signicantly positive, indicating
unconditional conservatism, and in consistency with H3, rms that that rms with high quality accounting disclosures exhibit higher
report high quality accounting disclosures are likely to display lower Rank UC and subsequently lower unconditional conservatism, since
unconditional conservatism. Rank UC is inversely related to unconditional conservatism.
Panel B of Table 5 presents the results obtained from Eq. (8)
5.4.1. The relation between conditional and unconditional conservatism regarding the conditional form of conservatism. Consistent with H4,
Panel A of Table 5 presents the results obtained from Eq. (7) the coefcient obtained for Rank UC is signicantly positive, reecting
regarding the unconditional form of conservatism. Consistent with H3, a negative association between conditional and unconditional con-
servatism, since the relation between Rank UC and unconditional
conservatism is negative. Consistent with H3, the coefcient obtained
Table 4 for QP is signicantly positive, implying that rms with high quality
Conservatism and high quality accounting disclosures. accounting disclosures exhibit higher conditional conservatism.
OLS regression

Variables Coefcients
5.4.2. Earnings sensitivity and conservatism
Panel A of Table 6 presents the ndings obtained from Eq. (10) for
CFD 0.013
the positive return sample and shows that consistent with H3, rms
(0.035)
OCF 0.334** that provide high quality accounting disclosures tend to exhibit
(0.166) higher conservatism. In detail, the higher the quality in nancial
CFD OCF 1.069*** reporting, the less prots are reected in the nancial statements
(0.348) of rms that bear good news, as shown by the negative coefcient
AQ (4) 0.293***
(0.103)
obtained for AQR. Likewise, Panel B presents the results for the
AQ CFD (5) 0.032 negative return sample and indicates that the higher the quality in
(0.049) nancial reporting, the more losses are reected in the nancial
AQ OCF (6) 0.182 statements of rms that exhibit bad news, as shown by the positive
(0.141)
coefcient obtained for AQR.
AQ CFD OCF (7) 1.176**
(0.535) Panel C of Table 6 presents the ndings obtained from Eq. (11) for
Constant 0.153 positive and negative return samples combined.3 As shown above, the
(0.019) coefcient obtained for AQR is signicantly negative, suggesting that
a6 + a7 0.994* the reported earnings of high quality accounting disclosers incorpo-
UC (AQ = 1) 0.282*
R2 adj. 0.21
rate less good news. Panel C also shows that the coefcient obtained
Sample size = 2,500 for RNDRAQ is signicantly positive, indicating that higher quality
in accounting disclosures would lead to greater conservatism in
***, ** and * indicate statistical signicance at the 1%, 5% and 10% level (two-tailed)
respectively. The sample period is 2005 to 2009. CFD is a dummy variable that takes 1 if
3
operating cash ows scaled by total assets is negative and 0 otherwise. OCF is operating The study has modied Eq. (11) to incorporate the AQ lag in the model in order to
cash ows scaled by total assets. AQ is a dummy variable that takes 1 for rms reporting examine the association between increases in accounting quality in the previous year
high quality accounting information and 0 otherwise. a7 captures conditional conservatism. and earnings conservatism in the current year. AQt 1 is a dummy variable
6 + 7 is an alternative measure of conditional conservatism. UC (AQ= 1) examines the representing the quality of reported accounting information, as dened in Eq. (1), in
relation between accounting quality and unconditional conservatism. This measure is year t 1. Consistent with the results reported in Table 6, the ndings (not reported
inversely related to unconditional conservatism and is derived from 4 +
5 x NOCF here) indicate that the coefcient obtained for Ri,t x NDRi,t x AQi,t1 is signicantly
(AQ= 1). 4 and
5 are the estimates of 4 and 5 presented in Eq. (6). NOCF (AQ= 1) is positive, implying that increases in accounting quality in the previous year would be
the proportion of rms that display high accounting quality and negative cash ows. linked to higher levels of earnings conservatism in the current year.
 G.E. Iatridis / International Review of Financial Analysis 20 (2011) 88102 99

Table 6 and difcult-to-verify items would restore investor condence and

Earnings sensitivity and conservatism. reduce agency costs (LaFond & Watts, 2008).
Panel A OLS regression Panel B OLS regression Panel C OLS regression Panel D of Table 6 presents the ndings obtained from Eq. (12)
regarding the relation of earnings conservatism and company nan-
Firms with positive Firms with negative Positive and negative
returns returns return samples combined cial variables. MVBVRNDR carries a signicantly negative coefcient,
which would reect the inclination of rms that are in a growth
Variables Coefcients Variables Coefcients Variables Coefcients
phase to provide less conservative accounting information in order to
R 0.261** R 0.177*** NDR 0.035
inuence and enhance their growth prospects. Information asymme-
(0.121) (0.056) (0.049)
AQ 0.168** AQ 0.092* R 0.238**
try between managers and stakeholders would enable the former to
(0.076) (0.049) (0.119) overstate prots and understate losses and it would therefore provide
AQ R 0.753* AQ R 0.081*** R NDR 0.072* the latter with misleading information and signals. TLSFURNDR is
(0.444) (0.030) (0.043) signicantly positive, indicating that stricter debt covenants and
Constant 0.229 Constant 0.015 AQ 0.350
bond contracting that would most likely accompany higher nancial
(0.060) (0.034) (0.519)
NDR AQ 0.063 leverage would reect lenders' demands for prudent, reliable and
(0.110) conservative earnings. Consistent with Frankel and Roychowdhury
AQ R 0.280*** (2006), the study shows that the reported earnings of rms with high
(0.092) leverage tend to exhibit higher conservatism. The coefcient obtained
R NDR AQ 0.587***
(0.177)
for AQRNDR is signicantly positive, suggesting that as nancial
Constant 0.229 reporting quality increases, the level of conservatism in reported
(0.286) earnings increases. AQRNDR is the only variable in the model that
R2 adj. 0.17 R2 adj. 0.22 2
R adj. 0.26 links accounting quality directly to earnings conservatism. Therefore,
Sample size = 1425 Sample size = 1075 Sample size = 2500
the positive coefcient that it carries conrms that accounting quality
Panel D OLS regression is positively associated with conservatism, indicating that nancial
Growth and leverage inuence on conservatism
reporting of high quality would reect the true and real nancial
picture of a rm and would be related to less, if not none, loss un-
Variables Coefcients
derstatements and prot overstatements, subsequently leading to
NDR 0.009 greater conservatism.
(0.009)
R 0.243***
(0.078)
6. Conclusions
R NDR 0.746***
(0.185) This paper focuses on UK listed companies and investigates the
MVBV 0.048*** motives for preparing annual reports of high or low quality. Studying
(0.018)
the motives for providing higher or lower quality accounting dis-
MVBV NDR 0.008
(0.076) closures would explain managers' behaviour when they are in a
MVBV R 0.004 growth area or in need for greater liquidity, equity or debt nancing,
(0.003) etc. The study also investigates the relation between the quality of
MVBV R NDR 0.058*
published nancial statements and rms' inclination to engage in
(0.031)
TLSFU 0.102**
earnings management practises. Subsequently, the study examines
(0.047) the association between the disclosure of high quality accounting
TLSFU NDR 0.023 information and conservatism. Here, the focus is on conditional con-
(0.019) servatism, which relates to difcult-to-verify accounting disclosures,
TLSFU R 0.271**
and unconditional conservatism, which relates to opportunistic man-
(0.116)
TLSFU R NDR 0.189** agerial efforts. The paper also concentrates on earnings conservatism
(0.099) and explores how major accounting variables, such as growth options
AQ 0.197* and leverage, may inuence the reporting of less prots and/or more
(0.109) losses in the nancial statements.
AQ NDR 0.015
(0.018)
Firms that display high quality reported information exhibit larger
AQ R 0.002 size and share trading volume and have a large part of rm ownership
(0.002) belonging to outsiders, which would subsequently imply higher
AQ R NDR 0.265** market visibility. They also exhibit higher protability and liquidity
(0.123)
measures, implying that good nancial results would motivate man-
Constant 0.187
(0.157) agers to provide high quality accounting information in order to
R2 adj. 0.34 positively affect investors' perceptions. Firms disclosing high quality
Sample size = 2,500 accounting information would carry greater informational value and
***, ** and * indicate statistical signicance at the 1%, 5% and 10% level (two-tailed) would be signicantly appreciated by market participants for their
respectively. The sample period is 2005 to 2009. R is the annual stock return. AQ is a honesty and integrity. Firms that have equity and debt capital needs
dummy variable that takes 1 for rms reporting high quality accounting information and demonstrate higher leverage would tend to prepare high quality
and 0 otherwise. NDR is a dummy variable that takes 1 for negative returns and 0
annual reports in order to reduce uncertainty and obtain nancing on
otherwise. MVBV is market value scaled by book value. TLSFU is total liabilities scaled
by shareholders' funds. better terms. In contrast, rms that experience higher growth appear
to disclose accounting information of lower quality perhaps to put
unfavourable managerial performance or poor investment project
reported earnings. Thus, as quality in nancial reporting increases, choices out of investors' sight and reinforce their growth prospects.
more losses are reected in company nancial statements, implying The change in management would encourage the new manage-
that changes in quality would inuence the amount of losses in- ment to reinforce the quality of their accounting disclosures as a means
corporated in earnings, and subsequently the level of earnings con- to improve their managerial prole. The same would hold when they
servatism. Hence, the provision of informative disclosures on losses are audited by a Big-4 auditor in order to obtain a favourable audit
100 G.E. Iatridis / International Review of Financial Analysis 20 (2011) 88102
report. The ndings show that even when they exhibit lower cash
ows or higher leverage, rms that disclose accounting information of
high quality tend to recognise large losses more timely and would
generally engage less in earnings management.
In contrast to unconditional conservatism, the conditional form
of conservatism increases the contracting efciency of reported
accounting information. Due to the fact that unconditional conserva-
tism could lead to lower agency costs and litigation risks and possibly
facilitate managerial opportunism, the application of the two forms of
conservatism varies from rm to rm, while they appear to
demonstrate a negative association. In line with the extant literature,
the study provides evidence that accounting quality in nancial
reporting promotes conservatism, indicating that nancial reporting
of high quality would be related to less loss understatements and
prot overstatements. The main nding is that rms that provide high
quality accounting disclosures apply conditional conservatism in their
nancial statements, while they restrict unconditional conservatism,
thereby further enhancing the quality and usefulness of the reported
accounting numbers, and increasing investors' condence on compa-
ny management. Hence, higher quality in nancial reporting would
indicate that more losses and difcult-to-verify items are reected in
company nancial statements.
In line with the argument that debt contracting is signicantly
associated with conservatism (Watts, 2006), the ndings show that
the reported earnings of rms with high leverage tend to exhibit
greater conservatism. The asymmetric disclosure of losses that the
study observes even for high quality disclosers that display bad news
(as well as for those that display good news) would be vital especially
in the case of cross-border borrowings. Whether high quality dis-
closers that prepare conservative nancial statements can obtain
lenders' trust and achieve better terms of borrowing would depend on
whether their nancial reporting quality is adequately communicated
to lenders and incorporated in lenders' perceptions (Ball et al., 2000).
This would essentially be related to the level of stock market ef-
ciency. The study also reports that rms that are in a growth phase
tend to provide less conservative accounting information in order to
inuence and enhance their growth prospects.
The ndings of the study may be of interest to nancial analysts,
stock market authorities and students of accounting. The study may
be useful particularly for accounting standard setters, while attempt-
ing to reduce information asymmetry between users of accounting
information and eliminate phenomena of managerial opportunism
and earnings management. The ndings of the study may also be of
use to investors and other users of accounting information, when
assessing the veriability, informativeness and comparability of
different sets of accounting information, especially in settings with
higher information asymmetry.
This paper contributes to the literature by providing evidence that
rms that use high standards of accounting quality in their nancial
reporting practises adopt a conservative approach in reporting losses
and prots, which would further reinforce the credibility of their
nancial statements. The study also contributes to the agency lit-
erature by explaining managerial behaviour and interaction with
market participants and demonstrating that a change in management
or equity and debt capital needs motivate managers to provide high
quality disclosures and simultaneously serve their managerial
objectives. The paper further contributes by showing that high quality
disclosers promote conditional conservatism and restrict uncondi-
tional conservatism, which implies that accounting quality would
enhance contracting efciency and reported numbers' validity, but
it would also reduce the likelihood of opportunism and earnings
manipulation.
The study subsequently implies that high quality disclosers would
promote the efciency of nancial reporting both in the absence
and in the presence of unfavourable and nancially adverse situations
and events. Firms would be able to gain investors' condence and
appreciation when they reported accounting information of high
quality, irrespective of the sign or the size of the nancial numbers,
their growth prospects, rm size, borrowing obligations or other
managerial goals. In contrast, the annual reports prepared by low
quality disclosers would convey poor information, which would
incorporate weaker expectations of future earnings, higher informa-
tion asymmetry and greater scope for earnings management. Poor
and uninformed public disclosures would subsequently cause inves-
tors' discontent and give rise to penalties, in terms of loss of reputation,
nes and restrictions from stock market authorities, stock price
declines, loss of investor and creditor condence, lower compensation,
etc. Thus, accounting disclosures that bear high accounting quality and
reect a conservative nancial reporting would enhance rm value
and would make annual reports more credible reducing market
participants' scepticism and authorities' scrutiny. This would tend to
be more intensive in countries with strong investor protection
mechanisms where the demand for high quality information is
stronger. In contrast, in countries with weak investor protection
mechanisms, the disclosure of difcult-to-verify accounting informa-
tion would be highly valued by the stock market and would attract
investors following the reduction of uncertainty and information
asymmetry.
The ndings of the study also have implications for the investigation
of the factors describing conservatism. While prior literature shows
that debt and compensation contracts largely inuence the demand for
conservatism, the study shows that the asymmetric recognition of
prots and losses has signicant implications for corporate governance
and assists in the monitoring process of managers. The presence of
conservatism and veriability in reported earnings would reect
investors' need to reduce agency costs and other value reductions that
stem from information asymmetry. Under conservatism, the asymmet-
ric disclosure of losses, as opposed to prots, would draw nancial
analysts' attention and motivate managers to focus on loss-generating
causes and comply with debt covenants and other commitments more
effectively. Likewise, the study provides evidence that the determinants
of accounting quality in annual reports, as set out in Section 4.2, en-
courage conservatism and would subsequently reduce information
asymmetry and lead to informed judgements and decisions.
The study will conclude by drawing a link to the recent nancial
crisis. Jeffrey (2008) argues that marking to market has contributed
signicantly to the nancial crisis. Given the companies' risk exposure,
the use of fair values, following the implementation of IFRSs, together
with the intense price uctuation during the nancial crisis has
made companies' assets more volatile and has adversely affected the
perceptions of market participants. This has in turn worsened the
unfavourable economic climate and business nancial prospects.
Wu (2010) has found that conservatism has beneted share-
holders during the nancial crisis. In a similar vein, Fang, Liu, and Xin
(2010) show that conservatism has contributed to the mitigation of
the adverse effects of the stock market crash risk, implying that
conservatism plays a signicant role towards market stability and
efciency. It is reported that the absence of earnings conservatism
prior to the nancial crisis period may have eventually resulted in
accelerating or magnifying the impact of the crisis (Mohammed,
Ahmed, & Ji, 2010). This suggests that accounting conservatism would
have increased from the period before the crisis to the current period.
Therefore, rms that use conservative nancial reporting would be
expected to better respond to the nancial crisis.
It is noteworthy that a positive association between conservatism
and rm stock returns has been reported during the period of the
nancial crisis, especially for rms with lower debt ratings, suggesting
that investors may be interested in credit ratings more than in
accounting information (Wu, 2010). It generally follows that con-
servatism supports corporate governance and reduces information
asymmetry and agency costs, which may result in a greater negative
impact on company nancial numbers and on investors' expected
 G.E. Iatridis / International Review of Financial Analysis 20 (2011) 88102
returns on investments during a nancial crisis (Johnson, Boone,
Breach, & Friedman, 2000).
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Dr George Iatridis is an Assistant Professor of Accounting and Finance at the
University of Thessaly, Greece. He is a member of the Accounting and Auditing
Oversight Board of the Ministry of Economics. He has worked as a lecturer in
Accounting and Finance at the University of Manchester, UK, and has also taught at the
University of Manchester Institute of Science and Technology (UMIST). Dr Iatridis
holds the degree of PhD from the University of Manchester, UK. His research interests
relate to international nancial reporting standards, nancial reporting and accounting
policy choice. Dr Iatridis teaches on graduate and executive postgraduate programmes
and serves on the editorial advisory boards of various academic journals.