The removal of “conservatism” as a qualitative characteristic from the Conceptual Framework of the IFRS has met with considerable resistance. This paper argues that conservatism has a role in accounting, but not as a qualitative characteristic. Rather, it serves as a defining principle for how accounting is to be done. It is thus central to resolving “recognition” and “measurement” issues in the Conceptual Framework, issues that determine what actually goes into the balance sheet and income statement but issues on which the Framework is particularly weak. As a “prudent reaction to uncertainty,” conservatism supplies the investor with information about the payoffs to investments, particularly the uncertainty involved in those investments.

This study develops a prediction model for identifying accounting fraud by analyzing the accounting information for Japanese firms. In particular, we (1) explore the characteristics of accounting fraud firms by analyzing financial information obtained from annual reports (yukashoken-houkokusho in Japanese) and (2) develop a model for predicting accounting fraud based on the characteristics of Japanese fraud firms. To identify the characteristic of fraud firms, we focus on 39 variables for the eight factors of “accruals quality,” “performance,” “nonfinancial measures,” “off-balance-sheet activities,” “market-related incentives,”“conservatism,” “real-activities manipulation,” and “Japanese-specific factors.” Through our univariate analysis and model building process, we find that “accrual quality,” “market-related incentives,” “real-activities manipulation,” “conservatism” and “Japanese-specific factors” are generally useful for detecting accounting fraud. We also conduct several analyses that test the predictive ability of our models, including (1) the detection rates of fraud firms, (2) Type I and Type II error rates, (3) marginal effect analysis on independent variables, and (4) robustness tests on time periods and industry clustering. We find that our models have generally higher predictive power in detecting accounting fraud. We expect that our models can be used widely in various accounting and finance practices.

We distinguish ambiguous common uncertainty (with unknown probability distribution) from risky common uncertainty (with known probability distribution) and examine how employee preference for relative performance contracts differs between the two conditions. Using economics and psychology theory in decision making under uncertainty, we hypothesize that (i) preference for relative performance contracts is low (high) when common uncertainty is ambiguous (risky); and (ii) confidence mediates the relation between ambiguity and preference for relative performance contracts. Results from a controlled laboratory experiment support these predictions. A follow-up experiment provides evidence that the direct effect of ambiguity and the mediating effect of confidence disappear if the contract is based on independent performance measures. Our study contributes to the literature on performance measurement, employee contract preference, and decision making under uncertainty.

This study aims to clarify the mechanism of the surprising earnings-returns relation observed at the aggregate level by offering evidence from Japan. Unlike firm-level evidence, recent Macro-Accounting research reports that when earnings changes and stock returns of individual firms are cross-sectionally aggregated, a significantly positive relation cannot be observed in the U.S. market. To explain this puzzling finding, Kothari et al. (2006) propose a hypothesis that negative effects of changes in the market-wide cost of capital cancel out positive effects of aggregate earnings changes on aggregate stock returns. Although this hypothesis is empirically supported in the U.S market, the validity of this hypothesis has not been sufficiently investigated in the Japanese market. Thus, we test the hypothesis and find it robustly supported in Japan. Our results show that positive effects of aggregate earnings changes on aggregate stock returns are canceled out by the effects of the market-wide cost of capital. We also find that these canceling effects stem from the market risk premium in Japan. An additional test we conduct shows that expected aggregate earnings changes and changes in the market risk premium are not negatively related. This result indirectly supports the hypothesis proposed by Kothari et al. (2006), because it undermines the competing hypothesis proposed by Sadka and Sadka (2009). These results should contribute to the related research areas, Macro-Accounting and accounting research on the cost of capital.