Conservatism - A Measurement Maze

Conservatism has been a bedrock of accounting as it governs the prudent preparation of financial statements to prevent over-optimism in financial reporting by management. However conservatism is like sunlight where one can feel the effects and warmth of it but has difficulty quantifying or measuring it. The purpose of this study is to investigate the robustness of accounting conservatism measures in their applications to different industries and conservatism impact assessment studies. Current conservatism research often adopts different conservatism measurement models arbitrarily and applies them to cross-industry samples without controlling for industry differences. There are also significant disagreements among findings of conservatism impact assessment studies. This study, through empirical assessment of an extensive sample of 43,434 firm-years over a 23-year period spanning 1988-2010, aims to provide evidence to show the significant inconsistencies among five popular conservatism measurement models. Using Penman and Zhang's (2002) earnings persistence regression and different unconditional conservatism measurement models, the conclusion reached is that Penman and Zhang's model does not hold for all industries. Therefore, this study raises concerns about the arbitrary application of conservatism measurement models in current research and the reliability of results produced by such studies.