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more complex investment pyramid layers recognize losses in a timely manner, they will have
lower costs of debt. Moreover, the empirical findings of Chi et al. (2009) and Hsu and Lin
(2013) also support the complementary perspective. However, there are some studies
supporting the substitutive perspective (e.g., Lin et al., 2009; Yang et al., 2014).
4. Effects of Conservatism on Institutions, Regulation, and Litigation
Ball, Kothari, et al. (2000) document that institutional factors can explain the properties
of earnings, especially timely incorporation of loss in accounting income. The primary
institutional variable is the prevailing system of law. They find that accounting earnings in
common-law countries are more conservative than in code-law countries.
Following Ball, Kothari, et al. (2000) and Ball et al. (2003), some studies try to explore
the “institutional” factors at the country level in more detail. For example, Bushman and
Piotroski (2006) find that, in addition to the type of legal system as studied by Ball, Kothari,
et al. (2000), other aspects of the legal (judicial) system, securities laws, and the political
economy also affect the financial reporting incentives of firms. In a cross-country setting,
Jayaraman (2012) uses the first-time enforcement of insider trading law as an exogenous
shock to examine its effect on conservatism. His findings are consistent with arguments that
enforcement of laws can increase earnings usefulness and trigger demand for conservatism.
Using an international sample of banks, Kanagaretnam et al. (2013) document that
individualism and uncertainty avoidance at the country level affect bank conservatism and
risk-taking behavior.
The prior literature also documents that mandating accounting standards alone may not
necessarily assure good quality financial reporting (Ball et al., 2003). The incentive of
managers or auditors at firm level may be equally important in determining the quality of
financial reporting. Ball, Robin, et al. (2000) examine the effect of accounting standards on
conservatism in a sample of Chinese listed firms that report under two accounting standards,
domestic ASBE and IAS, but they do not find significant evidence to support this argument.
They conclude that financial reporting quality cannot be improved by government mandated
accounting standards alone. Ball and Shivakumar (2005) use a sample of UK public and
private companies and find that the financial reporting quality is lower for private firms
because of different market demands and regulations.
Prior studies investigate the conservative behavior of auditors. They define “auditor
conservatism” as auditors’ preference for income-decreasing accounting choices (Kim et al.,
2003). Most studies document that auditor conservatism is related to BigN (Non-BigN)