Accounting standard’s effectiveness on equity overstatement – Conservatism when it matters

This paper evaluates the effectiveness of FASB’s standards on accounting conservatism when a firm is likely overstating assets or understating liabilities. Specifically, this paper considers whether conservatism increases due to SFAS 87, 106, 121, 142, and 123R, conditional on the firm being an aggressive reporter. To test these standards, I perform two time-series analyses from 1976 though to 2010. The first analysis compares the number of observations with a book to market ratio (BTM) greater than one to all observations at the industry level. The second determines whether each standard is correlated with a reduction in the probability of a firm having a BTM greater than one. I use the BTM greater than one to identify firms that should be more conservative (avoid equity overstatement), and to exclude those that are biasing earnings to artificially low levels. The results are consistent with only some of the standards, SFAS 106 (Employers’ Accounting for Postretirement Benefits Other Than Pension) and SFAS 142 (Goodwill and Other Intangible Assets), being effective in reducing equity overstatement.