Investigating the Asymmetric Recognition in the Bahrain Stock Exchange

[Abstract] In this paper, we investigate the differential speed with which good and bad news is incorporated into reported earnings. This has been characterized an indicator of conservatism. Our analysis is based on a sample from (50) companies listed in Bahrain stock exchange (BSE) over the period of years from 2005 to 2008, using the Basu (1997) model. We have confirmed that there is a much stronger contemporaneous relationship between bad news and earnings than between good news and earnings. [Keywords] asymmetric recognition; accounting conservatism; Bahrain stock exchange Introduction Conservatism has important economic functions. It is widely accepted that contractual relations, litigation, regulatory incentives, and, in some jurisdictions, links between taxation and reporting influence the demand for and supply of conservative accounting behavior; the accounting conservatism concept was controversial at the turn of last century and is still until now. Despite the critiques against this principle, it still plays an important principle in accounting practices (Watts, 2003). The conservatism is as capturing accountants' tending to require a higher degree of verification for recognizing good news than bad news in financial statements (Basu, 1 997), and concludes that conservatism exists in accounting where there is more timely recognition in earnings of bad news regarding future cash flows than good news. Conservatism is reflected in the asymmetric timeliness of loss vs. profit recognition, which stems from accountants' tendency to require a higher degree of verification for recognizing good news than bad news in financial statements: Anticipate no profit, but anticipate all losses. Today, in the middle of the waves of skepticism regarding financial reports, adherence to this principle has become a distinguishing aspect for companies with reference to the transparency of their financial reports and a standard for classifying countries according to adherence to accounting principles (Hamdan, 2010a) and conservatism, which discloses the expected losses aside from the anticipated earnings, in addition to the lowest values of assets. Accounting conservatism implies using strict standards when declaring profits (LaFond & Roychowdhury, 2008). This should not lead to undervaluing of assets or income (IASB framework, paragraph 37). Some of the benefits of Accounting Conservatism of financial lists are reducing opportunist motives for managers when disclosing optimistic results, increasing contracts control, and reducing court costs (Watts 2003a, b; Ball & Shivakumar, 2005). The need for accounting conservatism is related to the increase of credibility in accounting information (Heilman, 2008), conservatism of declaring good results of the company increases accounting credibility and the ability to predict the future. The need for conservatism appeared together with the Agency Theory (Basu, 1997) to solve the problem that might emerge between managers and stockholders on the separation between management and ownership. Suppose that the financial reports issued by the management were conservative (Ball, 2001; Watts, 2003), stockholders might resort to reducing management salaries to compensate for the difference attributed to the manager's care for their personal interests. To avoid such a situation, managers might resort to presenting more conservative numbers an indication of not caring for their personal interests (Watts & Zimmerman, 1983), thus shunning legal responsibility (Givoly & Hayn, 2000). Ahmed & Duellman, (2007) found out that accounting conservatism helps reduce agency costs. Finally, Hamdan (2010b) found that accounting conservatism contributes to the improvement of quality of financial reporting through an External Auditor for clean opinion. This study helps in establishing a relationship between the high level of accounting conservatism in Jordanian industrial companies and the improvement of the opinion of external auditor. …