Ambiguity and Investor Demand for Accounting Conservatism

• In Event: Investor Judgment and Decision Making

Abstract

This study suggests that investors have a demand for accounting conservatism that is due to their evaluation of expected profit and loss. We hypothesize that asymmetrically anticipating losses benefits investors that are excessively concerned about losses but not profits and further suggest that these concerns are subject to investors` knowledge about profit and loss probabilities, i.e. ambiguity. We experimentally analyze the willingness to invest in identical projects under either conservative or neutral accounting and find that the effect of ambiguity depends on the investment horizon and current profits of the firm. Ambiguity increases demand for conservatism for long but not short investment horizons. Given a short investment horizon, ambiguity reduces the demand for conservatism more when firm profits are low. Our analysis offers an alternative rational for conservatism, suggesting that it facilitates investment and reduces risk premiums required by investors.

Author

• Martin Staehle, University Bern