Accounting Conservatism Trends and Financial Distress: Considering the Endogeneity of the C-Score

Abstract

To consider a firm’s characteristics endogeneity and thereby determine its trend toward accounting conservatism, which in turn affects its financial distress, this study adopts the two-stage least squares approach. The first stage involves investigating the effect of the corporate characteristics on accounting conservatism. The empirical results indicate that financial distress and accounting conservatism exhibit a positive correlation. With respect to the non-financially distressed company, the accounting conservatism of the financially-distressed company is higher. The second phase in the logistic regression is to explore the relationship between the accounting conservatism trends and financial distress. The empirical results indicate that the trends and volatility of the accounting conservatism are significant and positively related to the financial distress, which may be due to the recognition of the company’s annual loss on one occasion or the accountants’ role in the function of exercising external oversight, thus increasing the company’s accounting conservatism. According to the empirical results of this study we have found that the accounting conservatism trends of different company characteristics helps to determine the signs of financial distress. It is recommended that within the management of the company’s operations the users of financial statements be aware of the trend and volatility of the accounting conservatism. This is of particular importance due to the probable development of the relevant decision-making processes of the company’s stakeholders.