Firms that report more conservative accounting information have a higher probability of receiving financing, according to a study by researchers at Universidad Carlos III de Madrid (UC3M). This occurs especially in the case of companies that usually have difficulties to obtain financing.
“In the study we show that firms with financing problems that provide more conservative accounting information, raise more funds. This allows them to undertake more profitable and less risky investment projects”, explained one of the authors of the research, Juan Manuel García Lara, full professor at the UC3M Department of Business Administration.
The new investments enable these companies to stay active and keep creating employment. According to Professor García Lara, “Our research shows that reporting conservative accounting information (versus excessively optimistic information) has positive economic effects for companies and for the economy as a whole.” García Lara published the study in the Journal of Accounting and Economics along with Beatriz García Osma, also a professor at UC3M, and Fernando Peñalva, a professor at Universidad de Navarra.
For a large firm, determining its profit is a difficult task, as profits are calculated based on a number of complex estimates. If the possible profit ranged, for example, between 5 and 10, 5 would be prudent or conservative, 7 neutral and 10 aggressive or risky. The researchers note that what this study reveals is that the economy does not reward an intermediate or neutral position, but does so with one that is more conservative and closer to 5.
“The optimal policy to obtain financing and for the economy to run better is to provide conservative information. This finding goes against the latest regulations adopted in the United States as well as in Europe, which assume that neutral information is ideal,” Professor Garcia Lara pointed out.
The study was carried out with US data provided by the financial service company Standard & Poor’s, comparing conservative and aggressive strategies of US companies over the past 40 years, and relating them to their capacity to obtain financing and to invest.
Firms’ access to financing sources is crucial to undertake new investment projects, and accordingly, reactivate the economic system and create employment. The information in the financial statements plays an important role in achieving these objectives, as it must generate enough confidence from capital providers so that financing flows toward the business sector.
García Lara, J.M.; García Osma, B.; Penalva, F. (2016): “Accounting Conservatism and Firm Investment Efficiency”, Journal of Accounting and Economics, 61(1): 221-238.