The Confounding Effect of Cost Stickiness in Conservatism Research

• In Event: Accounting Conservatism: Outcomes and Identification

Abstract

Sales decreases affect earnings more than sales increases because of cost stickiness. We hypothesize that this correlated omitted variable constitutes a confounding effect in standard conservatism models. Adding sales change direction to the Basu (1997) and Ball et al. (2013b) models decreases measured conservatism significantly and has a large impact on the relative ranking of firm-level conservatism estimates and on inferences about drivers of conservatism. Future empirical research on conditional conservatism should control for the potential confounding effect of sticky costs.

Authors

• Rajiv D Banker, Temple University

• Sudipta Basu, Temple University

• Dmitri Byzalov, Temple University

• Yun-Sheng Chen, Temple University