Accounting conservatism reduces bankruptcy risk

What is it about?

We show that more conservative accounting, which lowers net income, lowers net assets and reports bad earnings news sooner, actually decreases bankruptcy risk by enhancing cash balances by the reasoning that bankruptcy is a condition of cash versus profit insufficiency.

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Why is it important?

This study is important for standards setting, financial regulation, and financial risk management, and it helps to explain conservatism’s long-standing presence as a pervasive feature of financial accounting.