This paper provides early descriptive evidence on the effect of the adoption of IFRS 9 and COVID19 on banks' lending and regulatory capital. Using a sample of Spanish quoted banks, we find that the implementation of IFRS 9 resulted in an increase in the timeliness of loan loss recognition, and it only had a negative effect on lending for small banks that are timelier in recognizing expected credit losses. Timelier banks, large and small, increased their Tier 1 regulatory capital after the implementation of IFRS 9, although larger banks to a greater extent. Despite the extraordinary economic stimulus measures taken during the COVID-19 shock, there is a reduction in lending for small banks that are timelier in recognizing expected credit losses, and an increase in Tier 1 capital for timelier large banks. These results are not inconsistent with IFRS 9 having some procyclical traits, as it is not possible to anticipate truly unexpected shocks like COVID-19. The fact that IFRS 9 is more forward looking than its predecessor IAS 39, and that the observed effects are mild suggests that IFRS 9 is likely less procyclical than IAS 39.

In this study, we examine the trade-offs between earnings management (both accruals and real) and covenant violations by examining how they are associated with future accounting and stock market performance. We analyze a matched-pair sample of covenant violation firms with non-violation firms that have a similar risk of a covenant violation. We have three main findings. First, our evidence indicates that covenant violations are costly events for shareholders as lenders appear to use their control rights in ways that increase the likelihood of loan repayment but impose costs for shareholders. Second, there is limited evidence indicating covenant-related accrual-earnings management activities impose significant costs on shareholders, but we find shareholders are worse off following unsuccessful real earnings management. Third, our evidence indicates that, on average, shareholders at high violation risk firms are better off when their firms successfully engage in accruals earnings management to avoid a violation compared to shareholders at firms that violate a covenant but do not manage earnings. Thus, covenant-related earnings management may be in the best interests of shareholders and is not necessarily evidence of shareholder-manager agency conflicts.

Basu's [The Conservatism Principle and the Asymmetric Timeliness of Earnings. Journal of Accounting and Economics 24 (1997): 3-37] measurement of conditional conservatism as the asymmetric timeliness of earnings underlies hundreds of studies. However, many subsequent studies cast doubt on the extent to which Basu's measure captures conditional conservatism versus statistical biases or alternative constructs (collectively, biases), thereby questioning the validity of the inferences that empirical researchers draw from analyses using the measure. We modify Basu's measure in four simple ways to remove these biases. Our key modification is the inclusion of interactive controls for return variance, a volatility proxy that captures Patatoukas and Thomas' [More Evidence of Bias in Differential Timeliness Estimates of Conditional Conservatism. The Accounting Review 86 (2011): 1765-1794] return variance effect and various sources of economic optionality and adjustment costs. This inclusion captures volatility-related effects on both the level of earnings and the sensitivity of earnings to returns, and it allows the magnitudes of these effects to vary with the sign of returns. We conduct validation analyses using placebo-dependent variables, synthetic returns, and nonconditionally conservative earnings components that show our modified Basu measure is largely free of known biases. We further show that our measure is associated with contracting and other economic variables as predicted by theory. Our findings suggest that researchers can rely on our modified Basu measure to identify the determinants and effects of conditional conservatism.

We examine the impact of conditional conservatism on earnings management. Our findings support the view that conditional conservatism reduces accruals-based earnings management but also triggers a trade-off between accruals and real earnings management. In our main tests we use the passage of SFAS 121 as a plausibly exogenous regulatory change that increased the level of conditional conservatism but did not materially affect earnings management. We find that, after the regulation, treated firms reduce accruals-based earnings management and increase real earnings management, and are less likely to be marginal or habitual beaters of earnings benchmarks. Given the crucial role of earnings for firm valuation and analysis, and that conditionally conservative accounting choices are observable, our results should be of wide interest for investment professionals. (C) 2020 Elsevier Inc. All rights reserved.

This paper surveys both the theoretical and the empirical archival literature on conservatism when accounting information is used for debt contracting. The theoretical literature shows mixed results whether conservative accounting is desirable, which depends on the underlying agency problem, the information available, and the contracting space. The empirical literature takes a more holistic view in measuring the degree of conservatism. It studies a broad array of possible effects of conservatism in debt financing, but also beyond. The results overwhelmingly support the view that conservatism plays a useful role in debt contracting, although there are also some mixed results. We describe key results and empirical designs, and we provide suggestions for future research.

We empirically test the association between conditional conservatism and cost of equity capital. Conditional conservatism imposes stronger verification requirements for the recognition of economic gains than economic losses, resulting in earnings that reflect losses faster than gains. This asymmetric reporting of gains and losses is predicted to lower firm cost of equity capital by increasing bad news reporting precision, thereby reducing information uncertainty (Guay and Verrecchia ) and the volatility of future stock prices (Suijs ). Using standard asset-pricing tests, we find a significant negative relation between conditional conservatism and excess average stock returns over the period 1975-2003. This evidence is corroborated by further tests on the association between conditional conservatism and measures of implied cost of capital derived from analysts' forecasts