The Role of Cost Stickiness in Estimating Conditional Conservatism

Empirical research documents a linear relation between earnings and stock returns، and often attributes this pattern to conditional conservatism—more timely recognition of bad news than good news. This paper deals with another conception namely cost stickiness which can affect earning asymmetry. Cost stickiness denotes the asymmetric response of costs to sales increases versus sales decreases that is cost decrease in response of operation level decrease is lower than cost increase in response of operation level increase. Using panel data analysis، this paper examines the role of cost stickiness in estimating conditional conservatism of Iranian firms. The sample consists of 101 firms listed in Tehran Stock Exchange (TSE) over the period from 2007 to 2012 using object oriented sampling method. Results showed that the standard models for estimating conservatism، which do not control for cost stickiness، overestimate the average degree of conservatism. In other words، these models ignore cost stickiness as a determinant of conditional conservatism، leading to significant bias in estimating conservatism. More important، we find that standard models mistake variation in cost stickiness for variation in conservatism. The evidence demonstrates that considering the sticky costs is important for accurate understanding of conservatism.