We adopt a novel methodology that corrects for selection bias resulting from firms’ endogenous incorporation decision. Focusing on the period from when these ATLs became constitutional, a new measure of conservatism pdf find a negative association between ATLs and conservatism.
Our results suggest that ATLs decrease debtholder demand for conservatism by reducing agency costs of debt. Check if you have access through your login credentials or your institution. Conservatism mitigates under-investment as it facilitates access to debt financing. Conservatism facilitates financing projects that otherwise might not be pursued. The effect of conservatism is more pronounced when information asymmetry is high. Conservatism also reduces over-investment, even for low visibility investments. The results are robust to controls for governance and accounting reporting quality.
We argue that conservatism improves investment efficiency. This permits the financing of prudent investments that otherwise might not be pursued. Our empirical results confirm these predictions. We find that more conservative firms invest more and issue more debt in settings prone to underinvestment and that these effects are more pronounced in firms characterized by greater information asymmetries. We also find that conservatism is associated with reduced overinvestment, even for opaque investments such as research and development.