Conservatism and the Information Content of Earnings

This study finds that more conservative earnings have lower information content in that higher conditional conservatism decreases the speed with which equity investor disagreement and uncertainty resolve at earnings announcements. We find that a firm-year measure of conditional conservatism we develop is negatively related to the ratio of average daily equity trading volume (return volatility) during the annual earnings announcement window to average daily volume (volatility) during the post-announcement window. In addition, the reduced information content of earnings associated with conditional conservatism manifests as higher expected equity cost of capital and higher dispersion of analysts’ forecasts following earnings announcements. We also find positive returns subsequent to the earnings announcement for firms with higher conditional conservatism, particularly firms with positive earnings announcement returns, which is consistent with investors fixating on negatively biased earnings and higher costs of information processing.