Conservatism and the Value Relevance of Financial Information

This paper examines the association between conservation and value relevance of accounting information. Prior literature (Lev and Zarowin 1999) has suggested that consrvative accounting, especially the treatment of advertising and R&D, as one possible reason for decreasing value relevance. We measure conservatism using a variety of approaches in the extant literature including downward bias in book values (Beaver and Ryan 2000, Penman and Zhang 2002) and earnings (Lev and Nissim 2004). We examine the relationship between our measures of conservatism and the value relevance of accounting over a twenty-five year period from 1978 to 2002. We find that the value relevance of accounting has declined only for firms with the least conservative accounting and changed insignificantly for firms with the most conservative accounting. Further tests indicate that the decline in value relevance cannot be attrributed to alternate definitions of conservatism such as measures based on the asymmetric timeliness of earnings. Our findings limit the plausibility of attributiing decreasing value relevance to increasing conservatism in accounting.