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Managerial Caution, Operating Performance, and Accounting Conservatism

We investigate the relation between managerial (or corporate) caution, defined as the propensity to delay consequential decisions in the face of uncertainty, and conditional accounting conservatism — and document a substitution effect between the two. Economic theory predicts that caution reduces the probability of costly mistakes and improves the quality of information at managers’ disposal. Better-quality information ensures that good news in cautious firms is more likely to be persistent than in incautious ones, while bad news is more likely to be transitory. As a result, cautious firms report good news sooner and bad new later than incautious firms; i.e., the former exhibit lower conditional accounting conservatism than the latter. Our empirical results support the theoretical prediction. The study helps explain the standard setters’ position toward conservatism and sheds new light on the effect of the quality of managers’ private information on the quality of financial reporting.