The Relationship between Information Asymmetry and Conservatism

This paper studies the relationship between information asymmetry and accounting conservatism in financial statements. Information asymmetry between informed and uninformed equity investors creates an agency cost that increases the equilibrium return on the firm's equity. This effect gives parties to the firm an incentive to generate a mechanism that reduces information asymmetry. In the other hands Conservatism reduces the manager's incentives and ability to manipulate accounting numbers and then reduces the agency costs. Our empirical tests express that information asymmetry among equity investors is significantly positively related to conservatism. Further our tests confirm that changes in information asymmetry between equity investors lead changes in conservatism but conservatism doesnt lead to information asymmetry. This result rejects the FASB proposition that conservatism produces information asymmetry among investors.