Conservatism and Value Relevance: Evidence from the European Financial Sector

Abstract

Problem statement: We examine the levels of conservatism and value relevance existent in the financial sectors of three code-law European countries (Germany, France and Greece) and one common-law European country (UK). We investigate (a) whether conservatism exists during the last decade (1999-2008), (b) whether its level has changed over this period and (c) the impact of conservatism on the value relevance of earnings. Approach: We run regressions on two widely acclaimed models: The Basu’s model for the measurement of conservatism and the Easton and Harris’s model for the measurement of value relevance. We derive results for each country, but also for specific subgroups (pre- and post-IFRS period; low- and high-conservatism firms). Results: The results provide evidence that conservatism exists in all countries before the IFRS adoption and that its level has decreased after 2005 only in France and Germany. Moreover, in the post-IFRS period, investors’ perception on value relevance has decreased in code-law countries and increased in the UK. Splitting the samples according to the level of conservatism reveals that-except for Germany-during 2005-2008 higher (lower) conservatism entails less (more) value relevant earnings, contrary to the 1999-2004 findings. Conclusions/Recommendations: The research provides insights considering the consequences of IFRS adoption in the EU. We demonstrate that the new accounting framework affects differently the levels of conservatism and value relevance in four illustrative accounting regimes. This result implies that the variety among deep-rooted institutional factors within Europe will continue to exist even after implementing IFRS. Furthermore, the decreased adjusted-R²s of Basu and Easton and Harris models in the post-IFRS period imply that the once prevailing models may not be working effectively in the new era.