Does Conservatism Alleviates Firms from Under-over Investments in Pakistan?

Abstract

This study investigates the relationship between timely recognition of losses in financial reporting and investment efficiency, claiming that accounting conservatism improves the investment efficiency through mitigating under (over) investments of firms listed on Pakistan Stock Exchange (PSX). For this purpose, annual reports of 142 firms were selected on sample basis from six different sectors covering the period from 2006 to 2011. We find the existence of conservatism in financial reporting of Pakistani firms which was measured through Basu (1997) model, later to develop hypotheses that conservatism improves investment efficiency by alleviating firms from under and over-investments. The results found that accounting conservatism improves investment efficiency of Pakistani firms at insignificant level; however we found that conservatism restricts firms from over-investments at highly significant level. Furthermore, we find significant relation of CEO duality with investment efficiency and conservatism, which inferred that CEO duality, has influenced to improve investment efficiency in Pakistan. As a first study in context of Pakistan, it plays an important role in academic literature of accounting from developing country.

Keywords: Investment efficiency, Conservatism, Corporate Governance, Pakistan.