Influence of Ownership Structure on Accounting Conservatism- Evidence from Japanese Listed Companies -Abstract:
The notion that Japan is unique in its corporate governance and information
environment has been well established in the academic field. This study seeks to explore
how such uniqueness in ownership structure, one of the most important building blocks
of corporate governance, affects accounting conservatism. In particular, this study also
investigates the combined effects of ownership structure and other primary
determinants of accounting conservatism (i.e., debt contracting and the regulatory
efficacy of accounting standards) on navigating management's compliance to theconservative principal. I find that stable shareholdings are negatively related with thedegrees of conservative accounting in Japanese listed firms. Moreover, debt contracting
is latent in disciplining conservative accounting practice, which could be attributed tothe unique financing arrangements in Japan. On the other hand, accounting standards
prove to be relatively effective in regulating accounting decisions to report earnings
conservatively, thus restoring the credibility of accounting reports in Japan.

Keywords:
Ownership structure, Accounting conservatism, LASSO (least absolute shrinkage andselection operator), Empirical research1. Introduction
This paper focuses on effects of ownership structure, which is a crucial building blockof corporate governance, on accounting conservatism. This study also investigates therole of debt contracting and the regulatory efficacy of accounting standards in navigating
management’s compliance to conservatism principal under influence of different
ownership structure. This study differentiates itself from prior studies in that it also
aims to disentangle how correlations between ownership structures and the abovementioned determinants, i.e., capital structure and accounting regulations, affectaccounting conservatism in Japan.
The first ownership structure discussed is stable shareholdings. Corporate governancein Japan has commonly been compared to that in the Anglo-American business world.
Specifically, compared to the widely dispersed shareholding in the U.S., shares are
owned by a relatively small network of shareholders in Japan. On the other hand,financial institutions affiliating to the same conglomerate, as well as companies withlong-term business partnership, comprise a large proportion of shareholding in a typicalJapanese listed firm. In the meantime, Japanese listed firms still rely primarily on banks
for financial funding. In other words, the unique bank-firm relationship might result ina different information environment where debtholders’ standing in the firm resemble
that of the shareholders (e.g., Choi [2007]). Furthermore, it is also possible that theclosely-held ownership structure either gives rise to private comminution channels fordebtholders other than pubic accounting information (e.g., Kang and Shivdasani [1995],
Kang and Shivdasani [1996]) or alleviates interest conflicts between the debtholders andshareholders (e.g., Anderson et al. [2003]). In addition, to the extent interests ofshareholders and debtholders are intertwined as proportion of stable shareholding
increases, major loss recognition would on the contrary cut back on their economic gains
in the long run. Thus, I posit that a higher proportion of stable shareholdings leads tolower demands for accounting conservatism.
The second ownership structure examined in this study is involvement of foreign
capitals. While some existing literature links foreign investors with improved
information transparency and operation efficiency, others maintain that foreign
investors face more severe asymmetric information and higher monitoring costs suchthat they are unable to execute the presumable influence. Considering the uniquenessof Japan’s capital market, a higher proportion of foreign shareholding thereby does notnecessarily lead to a higher level of accounting conservatism.
As an important feature of this study, I also examine how debt contracting andefficiency of accounting standards’ ruling on accounting policies, when interacting with1

ownership structures, would influence accounting conservatism. The correlation
between ownership structure and financial leverage is worth noting because debt
contracting has traditionally been deemed as in favor of conservatism across different
accounting regimes. Notwithstanding, debtholders are likely to hold different needs forbad news as stated earlier under a unique information environment, which would affectthe level of accounting conservatism adopted by management. On the other hand, priorresearch also suggests that accounting standards activate conformity in speed withwhich bad news is reflected into earnings (e.g., Lawrence et al. [2013]). Nonetheless,firms domiciled in different countries often face different accounting practices andregulations. Therefore, whether accounting standards could still play an active role infacilitating contracting beyond its institutional structure is also of research interest.
Following prior studies, this study defines ruling efficacy of accounting standards as nondiscretionary conservatism. This study aims to disentangle how these factors (i.e.,
stable/foreign shareholdings, debt contracting, non-discretionary conservatism), whencombined, predict the level of accounting conservatism chosen by Japanese listed firms
by incorporating interaction terms into the regression model (e.g., a market-based model(i.e.,Basu [1997]), an accrual-based model (i.e., Ball and Shivakumar [2006])).
I find that the proportion of stable shareholdings, which is a more common shareholding
structure in Japan, is negatively related with the degrees of conservative accounting inJapanese listed firms. Moreover, consistent with the expectation, debt contracting islatent in disciplining conservative accounting practice, which could be attributed to theunique financing arrangements in Japan. Similarly, the interaction term between debt
contracting and stable shareholdings remains negative, suggesting that demands foraccounting conservatism from debtholders are not effective enough to suppress thenegative influence of stable shareholdings. This in turn reflects a multi-facet firm-bankrelationship in Japan. On the other hand, test results indicate a relatively powerful
enforcement environment in Japan as commitment to timely loss recognition will compel
management to rectify assets balance even in firms with higher proportion of stableshareholders when asset value is over evaluated.
Finally, although foreign equity displays little relevance to the level of accounting
conservatism, it exhibits higher demands of conservative accounting information when
there is a change in capital structure or under a well-rounded disclosure environment.
For example, the correlation between leverage and foreign equity is positive, which
implies that, as proportion of foreign equity increases, a constrained financial leverage
is more likely to evoke higher level of accounting conservatism. Findings in this study
also suggest that a proper enforcement mechanism will benefit the capital market as it
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assists in monitoring from foreign investors.
This study extends the extant literature as it not only focuses on the effect of a specific
type of ownership but also seeks to explore the cross-effects of debt contracting andaccounting standards disciplines. This study also shed new insights to the existing
conservatism literature on the nature of debt contracting, i.e., creditors’ monitoring
function in different information environment where creditors’ economic gains coincidewith those of large shareholders. These findings are of potential interest to both
regulators and international investors. More importantly, this study adds to ourunderstanding on the impact of institutional differences on accounting quality. Whileauthorities and academia strive to accommodate international accounting standards,
progress may lag on a practical level. In other words, imitating and adopting newer
accounting standards cannot really account for changes in earnings quality, due to theenvironments of various countries in which economies grew in indigenously.
In general, the analyses report consistent results with the hypotheses in this study.
However, this study still has several limitations stated as follows. First, I could notentirely rule out the possibilities that test results are biased due to model
misspecification and measurement errors in proxies for accounting conservatism. Second,
this study fails to consider other drivers for accounting conservatism suggest in earlier
research (e.g., interest conflicts between shareholders and management). Finally,
research design in this study fails to take the endogeneity concerns into consideration.
Specially, although little evidence is found with regards to the influence of foreign equity
on accounting conservatism, it is still possible that foreign investors incline to choose
firms with lower information asymmetric and such firms are thus expected to be moresensitive to bad news.
The remainder of this study proceeds as follows. Section 2 describes the features of theinstitutional settings in Japan. Section 3 develops the hypotheses and specifies themeasures and empirical models used for hypothesis testing. Section 4 summarizes the
sample selection process and presents the descriptive statistics. The test results of themain regressions, and robustness checks are presented in Section 5. Finally, Section 6
concludes and presents implications of the findings.

2 Literature Review
2.1 International Studies
The effects of ownership on financial reporting received prominence from the work of
Jensen and Meckling [1976]. As ownership structures are inherently more disperse in3

Anglo-American settings, the research interest of the literature mainly has been
confined to managerial ownership (e.g., Warfield et al. [1995], Cheng and Warfield[2005],Erickson et al. [2006], Lafond and Roychowdhury [2008], Kim and Lu [2011],
Kannan et al. [2014], and Basu et al. [2016]). However, research attempts to explore theinfluence of ownership on accounting conservatism is still limited. Velury and Jenkins[2006] examines the impact of institutional monitoring on earnings quality (i.e.,reporting timeliness). They find that, while institutional ownership is positively
correlated with timely disclosure in general, such effects are impaired as institutional
ownership becomes concentrated.
On the other hand, a growing body of literature has sought to understand the economic
effects of concentrated ownership on a firm’s informational environment across the globe.
The presence of large shareholders is traditionally viewed as optimal as large
shareholders are more incentivized than small shareholders to engage in monitoring
activities (e.g., Shleifer and Vishny [1986], Huddart [1993]). In other words, thetheoretical advantage of concentrated ownership is that bigger shareholders have higher
incentives and ability to become effective monitors of management. However, theinterests of large shareholders are not necessarily aligned with those of other investors,
and therefore, it is inconclusive whether the presence of large shareholders reduces
information asymmetry.
For instance, Haw et al. [2004] show that large control ownership, in the absence of
extra-legal regularities, induces aggressive income management for a large sample from
9 East Asian and 13 west European economies. 1 In addition, combining firm-level dataand country-level institutional differences, Attig et al. [2008] examine the influence ofmultiple large shareholders on the cost of equity financing in 21 countries in East Asia
and Europe2. While evidence confirms that the presence of large shareholders lowers
equity cost, Attig et al. [2008] suggests that such effects are more likely to hold in firms
whose voting power is proportionate to the voting size between large shareholders.
Boubaker et al. [2014] investigate the relationship between concentrated ownership andearnings management in a French setting. The authors conclude that controllingshareholders choose to conceal opportunistic practices to prioritize their own interests.
Collectively, effects of ownership concentration are relatively sensitive to institutional
1

The analysis subjects in East Asia are Hong Kong, Indonesia, Japan, Korea, Malaysia, thePhilippines, Singapore, Taiwan, and Thailand; the analysis subjects in Europe include Austria,
Belgium, Finland, France, Germany, Ireland, Italy, Norway, Portugal, Spain, Sweden, Switzerland,
and the U.K.
2 The analysis subjects in East Asia are Hong Kong, Indonesia, Korea, Malaysia, the Philippines,
Singapore, Taiwan, and Thailand; the analysis subjects in Europe include Austria, Belgium, Finland,
France, Germany, Ireland, Italy, Norway, Portugal, Spain, Sweden, Switzerland, and the U.K.

4

arrangements across countries and regions, such that these empirical findings are notreadily generalizable. In this sense, Japanese listed firms provide an interesting context
for examining the influence of ownership structures on firm performance. The following
subsection summarizes some institutional features that are salient to Japan anddiscusses how these features affect management’s disclosure decisions.
2.2 Ownership Structure in Japan
While accounting standards that originated in common-law countries (e.g., the US, UK,
Australia, and Canada) prioritize shareholder protection, accounting standards based incode-law countries (e.g., Germany, France, and Japan) are characterized as stakeholders oriented (e.g., Ball et al. [2003]).
Japanese corporate ownership is typically concentrated among strategically oriented
shareholders rather than fragmented among liquid investors, which has been widely
known as cross shareholding. Japanese corporate ownership differs from the structureof multiple large shareholdings in the U.S. in that: (1) a cross-shareholder holds theshares as a friendly insider sympathetic to incumbent management; (2) when disposalof shares is inevitable, a cross shareholder consults the firm or at least gives notice of its
intention to sell; (3) rather than focusing on returns to equity or the control rights of thefirm, cross shareholders focus on enhancing amicable relationships with each other andemphasize stable development through cross-shareholdings; (4) there is a strong bankinfluence on firms affiliated to the same large business groups (e.g., Prowse [1992],
Sheard [1994], Yafeh [2000]). As documented by Aoki [1990] and Guo et al. [2015], crossshareholding ownership alters the corporate governance environment in Japanese firmsin two critical ways. First, it makes hostile take-over attempts difficult which enables
management to focus on long-term value creation for the firm without paying undue
attention to short-term pressures arising from the market for corporate control. For
example, Jiang and Kim [2000] argue that to the extent that cross-shareholdings
improve the flow of information among investors in the same business group, it
substantially reduces information asymmetry and enhances the relevance of accounting
information. Shuto and Kitagawa [2011] find that institutional ownership alleviatesbond investors’ concern about management incentives and increases debt-contracting
efficiency. On the other hand, such arrangements also imply that cross shareholders takeonly a passive role in corporate governance, thereby delegating considerable discretion
to management (e.g., Denis and McConnell [2009]).
Teshima and Shuto [2008] and Shuto and Takada [2010] present initial evidence of therelationship between managerial ownership and conservatism for Japanese listed5companies. Evidence in their studies supports the incentive alignment perspective
regarding managerial ownership that the asymmetric timeliness of earnings is inversely
associated with extremely high or low managerial ownership. Evidence from Shuto andIwasaki [2014] further suggests that management has a strong propensity for earnings
smoothing once the proportion of stable shareholders begins to increase. In general,
evidence provided in prior studies supports the conjecture that conditional accounting
conservatism varies across firms with different ownership structure in Japan. A recent
study by Nagata and Nguyen [2017] examines the influence of ownership structure on
management earnings forecasts. They find that firms with greater bank ownership are
more likely to withhold private information and make material changes in their
management forecasts less timeously.
Recent research has also placed an on-going evolution of the Japanese business system
under the spotlight (e.g., Noda [2013], He and Shen [2014], Ullah [2017]). Much of thisemerging literature focuses on the role of foreign investors in strengthening monitoringmechanisms to deter management’s opportunistic behavior. Ahmadjian and Robbins[2005] set out to investigate the effects of foreign ownership on firm behavior under atypical stakeholder-oriented Japanese institutional framework. Using a sample set of1108 observations from 1991 to 2000, the authors find that the influence of foreign
investors on disinvestment is restricted by the level of existing domestic shareholders.
These findings are complemented by Desender et al. [2016]. Whilst acknowledge that
foreign ownership contributes to changes in governance processes, Desender et al. [2016]
also suggest that the effects of foreign investors are profound only for firms with lower
domestic ownership concentration.
Collectively, it cannot be denied that the roles of differential stakeholders in corporate
governance and accounting information are constantly evolving in response to rapidlychanging business environments and increased competition in Japan. As there is still alack of adequate empirical evidence on the effects of institutional differences on
accounting conservatism, this study aims to reassess the relevance of these stakeholders
to accounting information quality.

3 Hypothesis Development and Research Design
3.1 Hypothesis Development
I choose Japan as the subject of this research for the following reason. Corporate
ownership in Japan is concentrated among a stable network of investors with closebusiness ties. Rather than economic gains, these shareholders acquire shares based on
6strategic needs. Their long investment horizons would possibly prevent them from
fulfilling a monitoring and advisory role in management (e.g., Sheard [1994]). Bhagat etal. [2004] and Chen et al. [2007], among others, argue that while minority shareholders
and institutional investors aiming for short-term trading gains tend to require timely
disclosure of bad news, large shareholders with greater access to private information
might discourage such disclosure owing to their longer investment horizons. Table 1
shows some of the similarities and differences between listed firms in Japan and the U.S.
Table 1 Similarities and Differences between Japan and the U.S
Japan

U.S.A

Dispersed Shareholdings

×○Bank Dependence○×

Monitoring System○○

Two-step impairment test○○

Given the preceding discussion on Japan’s institutional background, banks in Japannot only play an important role as underwriters and lenders to the firms, but also carry
the same corresponding responsibilities as shareholders (e.g., Sheard [1994], Kang and
Shivdasani [1995], Kang and Shivdasani [1996]). Arguing from the perspective ofgovernance in the bank system, Kang and Liu [2008] cast doubt on the bank monitoring
theory and point out that a close bank-firm relationship leads to wealth being transferredfrom bank to borrowers through credit misallocation. Choi [2007] also indicates effects
of a firm’s bank dependence on conditional conservatism might significantly differ in abank-centered economy (e.g., Japan) and a market-centered economy (e.g., the U.S.).
Based on past research, I first expect that a higher percentage of stable shareholders
reduces the needs for accounting conservatism in Japanese listed firms. On the other
hand, as debt contracting is conducted more extensively through inside networks inJapan, I thereby posit that creditors’ monitoring will be less effective as the percentage
of stable shareholdings increases.
H1: Companies with higher stable shareholdings are more likely to have a lower levelof accounting conservatism.
H2: With respect to change in debt contracting, companies with higher stableshareholdings still exhibit lower levels of conservatism.

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On the other hand, whether foreign investment is positively related with firm
performance and accounting quality has been of great research interest in the literature(e.g., Jiang and Kim [2004], David et al. [2006], Leuz et al. [2009], Liu et al. [2017]). To
sum, two competing views are dominating research on the impact of foreign investors.
The first one, termed as governance spillover hypothesis, conjectures that foreign
investors’ superior knowledge and fiduciary duties enable them to execute influence on
the firm’s corporate governance and stimulate high quality public information. The otherone, known as information asymmetry hypothesis, posits that distance and otherinformation barrier limits foreign investors monitoring capability.
Combined with the discussion in Section 2.2, I thereby propose the following hypothesis
with regards to foreign shareholdings of Japanese listed companies in its null form.
H3: Companies with higher foreign shareholdings are more likely to have a higher levelof accounting conservatism.
On the other hand, accounting standards applied in a country could also lead tovariation in accounting quality (e.g., Barth et al. [2008], Peng et al. [2008], Ahmed et al.
[2013]). Prior research also infer that accounting standards are more likely to improve
accounting quality when rigorously enforced. For instance, Lawrence et al. [2013] showthat the timing of impairment loss disclosure is tallied with the requirements mandatedby accounting standards. Based on these findings, Lawrence et al. [2013] further specify
the mandatory power of statutory regulations in accounting conservatism as “nondiscretionary conservatism”, which creates an environment conducive to contracting
thereby mitigating conflicts of interest. In other words, accounting standards, whenstrongly enforced, are expected to constrain, if not eliminate, accounting opportunism.
As the third largest securities market in the world, Japan has long been honored as an
economic power with high quality of law enforcement (e.g., Cooke [1992]). However, thefallout from recent corporate scandals, such as those involving Olympus and Toshiba,
has overshadowed Japan’s legacy. Moreover, Japan, together with Germany, istraditionally viewed as a polar case of the U.S in terms of corporate governance style.
Hence, it is uncertain whether the theory of non-discretionary conservatism could bereadily applied to countries with different institutional features (e.g., Bushman et al.
[2004]). This leads to the final hypotheses in this study:
H4: Non-discretionary conservatism is less effective to impel accounting conservatismin firms with higher stable shareholdings.
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3.2 Variable explanation
To investigate the effect of ownership structure on conservatism in Japan, the following
five variables are used in the analysis.
In this study, 𝑆𝑇𝐴𝐵𝐿𝐸 represents the percentage of shares owned by the largest to thetenth-largest shareholders and other individuals or companies affiliated to the company
as defined by Quants Research. The data was manually collect from Quants Research.
An important limitation of this metric is that this measure includes managerial
shareholders. Although managerial ownership still constitutes a relatively small fractionof total shareholdings in Japanese listed firms (e.g., Shuto and Takada [2010], Shuto andKitagawa [2011]), test results in this study may biased by this limitation.
𝐽. 𝐹𝑂𝑅𝐸𝐼𝐺𝑁 represents the percentage of shares owned by foreign individuals or
institutions in Japan. This data was also collected from Quants Research. Foreign
investors are usually perceived to be more sophisticated in terms of investment
experience and the ability to analyze accounting information (e.g., Wang et al. [2008]).
Thus, higher proportion of foreign investors are expected to improve informationtransparency.
As discussed in introduction, reduced incentive in monitoring from creditors leads tolower demands for accounting conservatism. In this study, I employ the measure
𝐶𝐿𝐸𝑉𝑀𝑉𝑡−1 to represent the effects from the creditors. It is measured as the change intotal liabilities deflated by beginning-of-period market value of shareholder equity. It isconceivable that intense conflicts of interest between lenders and borrowers prompt
considerable monitoring from creditors. When a tight monitoring system is already inplace, the extra cost to supervise the additional financial liabilities should be almost zero.
Simply put, if supplementary monitoring can be implemented at no additional cost, thenit is logical for creditors to seek for more conservatism. This renders the predicted signfor 𝐶𝐿𝐸𝑉𝑀𝑉𝑡−1 to be positive. On the contrary, management, as the other party in a debt
contract, has the incentive to deny loss recognition so as not to inflate the debt ratio. A
unique governance mechanism (e.g., lenders’ insensitivity to change in the borrower’s
capital cost, a more powerful network of shareholders) can easily trigger such discretions
over loss recognition.
In this study, to test H4, the measure of ASSET-BTM (𝐴𝐵𝑇𝑀𝑡−1) is employed to explore
the effects of accounting standards enforcement on the level of accounting conservatism.
𝐴𝐵𝑇𝑀𝑡−1 serves as a bench mark for the need to write off underperforming assets. As
demonstrated in Lawrence et al. [2013], when 𝐴𝐵𝑇𝑀𝑡−1 grows higher, a loss is more
likely to ensue if management commits to accounting standards.

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3.3 Research Design
3.3.1 Modified Basu Model
In line with Lafond and Roychowdhury [2008] and Ahmed and Duellman [2013], thisstudy employs a variation of Basu’s asymmetrical timeliness coefficient model to test the
hypotheses developed in Section 3.1. Under the framework of Basu [1997], an
asymmetric timeliness measure (ρ3 ) captures the incremental timeliness of current
earnings and recognizes economic losses versus economic gains.
Eq.1

𝐸t = ρ0 + ρ1 𝐷𝑅𝑡 + ρ2 𝑅𝑡 + ρ3 𝐷𝑅𝑡 ∗ 𝑅𝑡 + εt

𝐸𝑡 denotes the net income in fiscal year t deflated by market capitalization measured
at the end of fiscal year t－1. 𝑅𝑡 denotes the buy-and-hold return on common stock forthe twelve months ending three months after the end of fiscal year t. 𝐷𝑅𝑡 is a dummy
variable that equals 1 if 𝑅𝑡 is negative and is 0 otherwise. Accordingly, asymmetrictimeliness measure ( ρ3 ) will be positive if bad news is incorporated into earnings
information in a timelier manner than is good news.
Model 1:𝐸t = ρ0 + ρ1 𝐷𝑅𝑡 + ρ2 𝑅𝑡 + ρ3 𝐷𝑅𝑡 ∗ 𝑅𝑡 + ρ4 𝑋𝑡−1 + ρ5 𝐷𝑅𝑡 ∗ 𝑋𝑡−1 + ρ6 𝑅𝑡 ∗ 𝑋𝑡−1 + ρ7 𝐷𝑅𝑡 ∗ 𝑅𝑡 ∗ 𝑋𝑡−1 +ρ8 𝐶𝐿𝐸𝑉𝑀𝑉𝑡−1 + 𝜌8 𝐷𝑅𝑡 ∗ 𝐶𝐿𝐸𝑉𝑀𝑉𝑡−1 + 𝜌9 𝑅𝑡 ∗ 𝐶𝐿𝐸𝑉𝑀𝑉𝑡−1 + ρ10 𝐷𝑅𝑡 ∗ 𝑅𝑡 ∗ 𝐶𝐿𝐸𝑉𝑀𝑉𝑡−1 + 𝜌11 𝐴𝐵𝑇𝑀𝑡−1 +𝜌12 𝐷𝑅𝑡 ∗ 𝐴𝐵𝑇𝑀𝑡−1 + ρ13 𝑅𝑡 ∗ 𝐴𝐵𝑇𝑀𝑡−1 + 𝜌14 𝐷𝑅𝑡 ∗ 𝑅𝑡 ∗ 𝐴𝐵𝑇𝑀𝑡−1 + 𝑦𝑒𝑎𝑟 𝑓𝑖𝑥𝑒𝑑 𝑒𝑓𝑓𝑒𝑐𝑡𝑠 +𝑖𝑛𝑑𝑢𝑠𝑟𝑡𝑦 𝑓𝑖𝑥𝑒𝑑 𝑒𝑓𝑓𝑒𝑐𝑡𝑠 + εt

Model 2:𝐸t = ρ0 + ρ1 𝐷𝑅𝑡 + ρ2 𝑅𝑡 + ρ3 𝐷𝑅𝑡 ∗ 𝑅𝑡 + ρ4 𝐷. 𝑋𝑡−1 + ρ5 𝐷𝑅𝑡 ∗ 𝐷. 𝑋𝑡−1 + ρ6 𝑅𝑡 ∗ 𝐷. 𝑋𝑡−1 + ρ7 𝐷𝑅𝑡 ∗ 𝑅𝑡 ∗𝐷. 𝑋𝑡−1 + ρ8 𝐶𝐿𝐸𝑉𝑀𝑉𝑡−1 + 𝜌8 𝐷𝑅𝑡 ∗ 𝐶𝐿𝐸𝑉𝑀𝑉𝑡−1 + 𝜌9 𝑅𝑡 ∗ 𝐶𝐿𝐸𝑉𝑀𝑉𝑡−1 + ρ10 𝐷𝑅𝑡 ∗ 𝑅𝑡 ∗ 𝐶𝐿𝐸𝑉𝑀𝑉𝑡−1 +𝜌11 𝐴𝐵𝑇𝑀𝑡−1 + 𝜌12 𝐷𝑅𝑡 ∗ 𝐴𝐵𝑇𝑀𝑡−1 + ρ13 𝑅𝑡 ∗ 𝐴𝐵𝑇𝑀𝑡−1 + 𝜌14 𝐷𝑅𝑡 ∗ 𝑅𝑡 ∗ 𝐴𝐵𝑇𝑀𝑡−1 + 𝜌15 𝐶𝐿𝐸𝑉𝑀𝑉𝑡−1 ∗𝐷. 𝑋𝑡−1 + 𝜌16 𝐷𝑅𝑡 ∗ 𝐶𝐿𝐸𝑉𝑀𝑉𝑡−1 ∗ 𝐷. 𝑋𝑡−1 + 𝜌17 𝑅𝑡 ∗ 𝐶𝐿𝐸𝑉𝑀𝑉𝑡−1 ∗ 𝐷. 𝑋𝑡−1 + ρ18 𝐷𝑅𝑡 ∗ 𝑅𝑡 ∗ 𝐶𝐿𝐸𝑉𝑀𝑉𝑡−1 ∗𝐷. 𝑋𝑡−1 + ρ18 𝐴𝐵𝑇𝑀𝑡−1 ∗ 𝐷. 𝑋𝑡−1 + ρ17 𝐷𝑅𝑡 ∗ 𝐴𝐵𝑇𝑀𝑡−1 ∗ 𝐷. 𝑋𝑡−1 + ρ18 𝑅𝑡 ∗ 𝐴𝐵𝑇𝑀𝑡−1 ∗ 𝐷. 𝑋𝑡−1 + ρ19 𝐷𝑅𝑡 ∗𝑅𝑡 ∗ 𝐴𝐵𝑇𝑀𝑡−1 ∗ 𝐷. 𝑋𝑡−1 + 𝑦𝑒𝑎𝑟 𝑓𝑖𝑥𝑒𝑑 𝑒𝑓𝑓𝑒𝑐𝑡𝑠 + 𝑖𝑛𝑑𝑢𝑠𝑟𝑡𝑦 𝑓𝑖𝑥𝑒𝑑 𝑒𝑓𝑓𝑒𝑐𝑡𝑠 + εt

𝑋𝑡 denotes ownership characteristics salient to Japan with respect to prior research.
In view of Japan’s unique institutional environment, variables representing stableshareholding (𝑆𝑇𝐴𝐵𝐿𝐸) and foreign investors (𝐽. 𝐹𝑂𝑅𝐸𝐼𝐺𝑁) are included in the regressions.
Model 1 is the base line estimation equation in this study. The interaction term 𝐷𝑅𝑡 ∗𝑅𝑡 ∗ 𝑋𝑡−1 indicates the level of accounting conservatism for a particular ownership type.
10

H1 predicts that companies choose less conservative accounting policy when proportionof stable shareholders are relatively higher. Thus, the predicted sign for 𝐷𝑅𝑡 ∗ 𝑅𝑡 ∗𝑆𝑇𝐴𝐵𝐿𝐸𝑡−1 is negative. On the other hand, 𝐷𝑅𝑡 ∗ 𝑅𝑡 ∗ 𝐽. 𝐹𝑂𝑅𝐸𝐼𝐺𝑁𝑖,𝑡−1 measures theinfluence of foreign investors. When the presence of foreign investors is effective in
improving the sensitivity of earnings to bad news, the sign for the abovementioned
interaction terms is predicted to be positive.
As predicted in previous research, variation in leverage generates different demands
for timely loss recognition from creditors’ side (e.g., LaFond and Watts [2008], Nakamura[2009]). Hence, an increase in debt contracting is likely to induce stricter monitoring of
the debtholders, implying a higher level of accounting conservatism. In this case, thesign for 𝐷𝑅𝑡 ∗ 𝑅𝑡 ∗ 𝐶𝐿𝐸𝑉𝑀𝑉𝑡−1 is expected to be positive.
𝐴𝐵𝑇𝑀𝑡−1 is included in this model to verify the effects of accounting standards on
management. Evidence documented in Lawrence et al. [2013] show that nondiscretionary conservatism explains a substantial proportion of variation in conservative
accounting choices. They find that management commits to accounting standards andrecognizes impairment losses in accordance with the decrease in the asset values. The
predicted sign for 𝐷𝑅𝑡 ∗ 𝑅𝑡 ∗ 𝐴𝐵𝑇𝑀𝑡−1 is positive. Nevertheless, in view of the discussion
in the previous sections, it is logical to assume that when influential shareholders
discriminate loss recognition, monitoring from the creditors alone may not be effective
enough to offset the negative impact of other stakeholders.
𝑆𝐼𝑍𝐸t−1 is considered in Model 1 to control for firm size (e.g., Lafond and Roychowdhury[2008], Ahmed and Duellman [2013]). 𝑆𝐼𝑍𝐸t−1 is natural logarithm of the company’smarket capitalization.
Model 2 is developed based on Model 1 to test the cross effects of debt contracting (nondiscretionary conservatism) and ownership structure. Analyzing their interaction terms
would thus generate a fuller picture of the effects of ownership under different
circumstance. In Model 2, a dummy variable 𝐷. 𝑋𝑡−1 is employed to examine the level ofconservatism shown by companies with higher proportion of stable ownership or foreign
ownership. 𝐷. 𝑆𝑇𝐴𝐵𝐿𝐸t−1 and 𝐷. 𝐽𝐿𝐹𝑂𝑅𝐸𝐼𝐺𝑁t−1 take the value of one if the proportionof stable ownership or foreign ownership is above their means. I expected the sign on
𝐷𝑅𝑡 ∗ 𝑅𝑡 ∗ 𝐷. 𝑆𝑇𝐴𝐵𝐿𝐸t−1 and 𝐷𝑅𝑡 ∗ 𝑅𝑡 ∗ 𝐷. 𝐽𝐹𝑂𝑅𝐸𝐼𝐺𝑁t−1 to be negative. The signs on
𝐷𝑅𝑡 ∗ 𝑅𝑡 ∗ 𝐷. 𝑆𝑇𝐴𝐵𝐿𝐸t−1 and 𝐷𝑅𝑡 ∗ 𝑅𝑡 ∗ 𝐷. 𝐹𝑂𝑅𝐸𝐼𝐺𝑁 are the same in Model 1.
For instance, as the predicted sign on 𝐷. 𝑆𝑇𝐴𝐵𝐿𝐸𝑡−1 is negative, a positive coefficienton 𝐶𝐿𝐸𝑉𝑀𝑉𝑡−1 ∗ 𝐷. 𝑆𝑇𝐴𝐵𝐿𝐸𝑡−1 then indicates the negative effects of stable shareholdings
are neutralized. In a similar vein, sign on 𝐶𝐿𝐸𝑉𝑀𝑉𝑡−1 ∗ 𝐷. 𝐽𝐹𝑂𝑅𝐸𝐼𝐺𝑁𝑡−1 are expected to
be positive as foreign investors could still restrain management incentives and other11

shareholders’ disclosure preference when financial capacity becomes constrained. As
indicated in Section 3.2, the measure of 𝐶𝐿𝐸𝑉𝑀𝑉𝑡−1 proposes two alternative scenarios
over the influence of leverage change. In other words, when the sign on interaction terms
between 𝐶𝐿𝐸𝑉𝑀𝑉𝑡−1 and 𝐷. 𝑆𝑇𝐴𝐵𝐿𝐸𝑡−1 turns to negative, it then infers that stableshareholding enables firms to adopt less conservative accounting policy as monitoringfrom debt holders is compromised. A negative sign on interaction terms between
𝐶𝐿𝐸𝑉𝑀𝑉𝑡−1 and 𝐷. 𝐽𝐹𝑂𝑅𝐸𝐼𝐺𝑁𝑡−1 then suggest the presence of foreign equity does notcounteract managerial discretion. On the other hand, the expected sign on all interaction
terms with 𝐴𝐵𝑇𝑀𝑡−1 is positive as strictly enforced accounting standards are
anticipated to restore conservative reporting in face of any institutional infrastructure.

3.3.2 GLM-SELECT
In this section, I examine how ownership structure affect accounting conservatism byletting the main ownership variable interact with leverage and ASSET-BTM ratio. As
indicated in the introduction, I posit that, given the unique information environment inJapan, the level of conservatism is determined by the extent to which interests ofcontracting parties involved are opposed or intertwined. For example, accounting
numbers would be less conservative as influence of the stable shareholders outplays thatof creditors. Furthermore, the interplay of different forces affected by accounting
conservatism could potentially lead to even lower sensitivity to economic losses. Hence,
it is crucial to disentangle the reciprocal effects between these stakeholders.
On the other hand, one of the greatest challenges faced by empirical analysis is theselection of a valid set of variables which best fit the observed data. In an effort toadvance the findings in this study, I perform a general linear models (GLM) selection
procedure proposed by Osborne et al. [2000]. General linear model selection is adiagnostic technique emphasizes the accuracy of a model and more importantly
accommodates interaction terms under a linear regression framework. In other words,
it improves predictive performance on the cross-effects between the predictors and in themeantime balances goodness of fit. Model 3 is used to assess the influence of ownership
structure on firm-level conservatism in Japan. Two metrics for accounting conservatism(i.e., T_SCORE, CONSKEW) are employed as the dependent variable in each model.
Model 3:𝑑𝑒𝑝𝑒𝑛𝑑𝑒𝑛𝑡 = 𝛼0 + 𝛼1 𝐶𝐿𝐸𝑉𝑀𝑉𝑡−1 + 𝛼2 𝐴𝐵𝑇𝑀𝑡−1 + 𝛼3 𝑆𝑇𝐴𝐵𝐿𝐸𝑡−1 + 𝛼4 𝐶𝐿𝐸𝑉𝑀𝑉𝑡−1 ∗ 𝑆𝑇𝐴𝐵𝐿𝐸𝑡−1 +𝛼5 𝐴𝐵𝑇𝑀𝑡−1 ∗ 𝑆𝑇𝐴𝐵𝐿𝐸𝑡−1 + 𝛼6 𝐽. 𝐹𝑂𝑅𝐸𝐼𝐺𝑁𝑡−1 + 𝛼7 𝐶𝐿𝐸𝑉𝑀𝑉𝑡−1 ∗ 𝐽. 𝐹𝑂𝑅𝐸𝐼𝐺𝑁𝑡−1 + 𝛼8 𝐴𝐵𝑇𝑀𝑡−1 ∗12

𝐽. 𝐹𝑂𝑅𝐸𝐼𝐺𝑁𝑡−1 + 𝑐𝑜𝑛𝑡𝑟𝑜𝑙𝑠 + 𝜀𝑡

where𝑑𝑒𝑝𝑒𝑛𝑑𝑒𝑛𝑡𝑡 :𝑇_𝑆𝐶𝑂𝑅𝐸𝑡 :a firm-year conservatism measure devised in Khan and Watts [2009].

𝐶𝑂𝑁𝑆𝐾𝐸𝑊𝑡 :the difference between the skewness of cash flows from operating
activities and the skewness of net income using a three-year rolling
window.3

ownership variable:
𝑆𝑇𝐴𝐵𝐿𝐸𝑡−1 :the percentage of shares owned by the largest to the tenth-largest
shareholders and other persons or companies affiliated with thecompany as defined in Quants Research

𝐽. 𝐹𝑂𝑅𝐸𝐼𝐺𝑁𝑡−1: the percentage of shares owned by foreign individuals or institutions inJapan𝑐𝑜𝑛𝑡𝑟𝑜𝑙𝑠 include interacting terms and the following variables.
𝐶𝐿𝐸𝑉𝑀𝑉𝑡−1 :change in total liabilities deflated by beginning-of-period market
capitalization

𝐴𝐵𝑇𝑀𝑡−1 :total assets deflated by the sum of market capitalization and total assets
minus common equity, both measured at the end of fiscal year t－1

𝑆𝐼𝑍𝐸𝑡−1 :natural logarithm of the company’s market capitalization.

𝑃𝑃𝐸𝑡−1:the proportion of property, plant and equipment assets to total assets inyear t－1.

𝑊𝐸𝐴𝐾𝑡 :

a dummy variable takes the value of 1 if 𝐿𝑅𝑂𝐴𝑡 or 𝐿𝑅𝑡 is below 5% and
0 otherwise. 𝐿𝑅𝑂𝐴t is a lag indicator for 𝑅𝑂𝐴, computed as the averagevalue of 𝑅𝑂𝐴𝑡−1 and 𝑅𝑂𝐴𝑡−2. 𝐿𝑅𝑡 is a lag indicator for 𝑅𝑂𝐴, computed
as the average value of 𝑅𝑡−1 and 𝑅𝑡−2 . 𝑅𝑂𝐴𝑡 is measured as income
before extraordinary items deflated by book value of total assets, bothmeasured at the end of fiscal year t. 𝑅𝑡 is the buy-and-hold return oncommon stock for the twelve months ending three months after the end

3 𝐶𝑂𝑁𝑆𝐾𝐸𝑊𝑡(𝐶𝑂𝐹𝑖,𝑡 −𝜇𝐶𝑂𝐹𝑖,𝑡 ) 3(𝑁𝐼𝑖,𝑡 −𝜇𝑁𝐼𝑖,𝑡 ) 3

𝜎𝐶𝑂𝐹𝑖,𝑡𝜎𝑁𝐼𝑖,𝑡= E() − E()

where
𝐶𝑂𝐹𝑡 : cash flow from operating activities deflated by total assets at the end of year t.
𝑁𝐼𝑡 : net income deflated by total assets at the end of year t.
𝜇𝐶𝑂𝐹𝑖,𝑡 : mean of cash flow from operating activities.
𝜎𝐶𝑂𝐹𝑖,𝑡 : standard deviation of the distribution of cash flow from operating activities.
𝜇𝑁𝐼𝑖,𝑡 : mean of net income.
𝜎𝑁𝐼𝑖,𝑡 : standard deviation of the distribution of net income.

13

of fiscal year t.
𝐷𝐸𝐵𝑇𝑡−1 :proceeds from the issuance of bonds in year t－1 deflated by market
capitalization of common equity at the end of year t－1.

𝐺𝑊𝑡−1 :

book value of goodwill deflated by total assets, both measured at the endof fiscal year t－1.

𝐼𝑁𝑇𝐴𝑡−1 :book value of intangible assets deflated by total assets, both measured
at the end of fiscal year t－1.

𝑅𝐷𝑡−1 :

expenditure on research and development deflated by total sales, bothmeasured at the end of fiscal year t－1

𝑙𝑛𝐴𝐺𝐸𝑡−1 :the natural logarithm of firm age

The first dependent variable employed in the model is 𝑇_𝑆𝐶𝑂𝑅𝐸𝑡 , which measures thedegree of conditional conservatism suggested in Khan and Watts [2009]. Based on theframework of Basu [1997], they define conditional conservatism as a function of firm size
(𝑆𝐼𝑍𝐸 ), marker-to-book ratio ( 𝑀𝑇𝐵 ), and market value leverage (𝐿𝐸𝑉𝑀𝑉 ). Although
Basu’s [1997] approach has been validified in extant literature, controversy still remains
regarding its model specification and choice of deflator ( e.g., Dietrich et al. [2007]). To
ameliorate the concerns, I followed Givoly and Hayn [2000] and employed 𝐶𝑂𝑁𝑆𝐾𝐸𝑊𝑡 as
a non-market-based measure for accounting conservatism. It is computed as thedifference between the skewness of net income and the skewness of cash flows fromoperating activities using a three-year rolling window. The two measures have been
extensively applied in previous studies (e.g., García Lara et al. [2016], Zhang [2008]) andpresent advantage of allowing me to perform tests on a firm-year level. Both 𝑇_𝑆𝐶𝑂𝑅𝐸𝑡
and 𝐶𝑂𝑁𝑆𝐾𝐸𝑊𝑡 are positively correlated with the level of conservatism.
As outlined in the previous section, I expect that larger proportion of stable ownershipwill counteract conservative disciplines. Therefore, I expect that it will negatively
associate with the response variables (𝑇_𝑆𝐶𝑂𝑅𝐸𝑡 and 𝐶𝑂𝑁𝑆𝐾𝐸𝑊𝑡 ) and will be includedin the selected model. In contrast, when firms with a larger proportion of foreign
shareholders cut loss and abandon poorly performing projects in a timelier manner,
𝐽. 𝐹𝑂𝑅𝐸𝐼𝐺𝑁𝑡−1-related items will be positively linked with 𝑇_𝑆𝐶𝑂𝑅𝐸𝑡 and 𝐶𝑂𝑁𝑆𝐾𝐸𝑊𝑡 .
To identify the combined effects of accounting standards or leverage on accounting
conservatism, this section also focuses on the interpretation of the coefficients on theinteraction terms. I expect that the existing firm-bank relationship in conjunction withhigher concentration in ownership will compromise banks’ monitoring efficiency.
Interaction terms involve 𝐶𝐿𝐸𝑉𝑀𝑉𝑡−1 are thereby intended to capture the effect ofleverage. To the extent the needs for timelier loss recognition diminishes, coefficient on
14

dual interaction term (𝐶𝐿𝐸𝑉𝑀𝑉𝑡−1 ∗ 𝑋𝑡−1), when associate with stable shareholdings, is
expected to be negative. Prior study infers that non-discretionary conservatism( 𝐴𝐵𝑇𝑀𝑡−1 ) impels accounting conservatism and rules out opportunistic accounting
choices. Therefore, I expect the inclusion of measure 𝐴𝐵𝑇𝑀𝑡−1 will offset the negative
influence of stable shareholdings. Therefore, estimate for 𝐴𝐵𝑇𝑀𝑡−1 ∗ 𝑆𝑇𝐴𝐵𝐿𝐸𝑡−1 ispositive. On the other hand, sign on the dual interaction terms (𝐶𝐿𝐸𝑉𝑀𝑉𝑡−1 ∗ 𝑋𝑡−1 and𝐴𝐵𝑇𝑀𝑡−1 ∗ 𝑋𝑡−1 ) associated with foreign shareholdings is expected to be positive if
foreign equity is positively correlated with accounting conservatism.
𝑐𝑜𝑛𝑡𝑟𝑜𝑙𝑠 include interacting terms and the following predictors. 𝑃𝑃𝐸𝑡−1 stands for thetangibility of assets and is measured as the proportion of property, plant and equipment
assets to total assets in year t－1. Due to the effects of learning curve and survival bias,
older and larger firms are more likely to be predictable than younger ones. Moreover,firm age also indicates the length and quality of bank-firm relationship. For Japaneselisted companies, firm age data is collected from Quants Research database. Other
variables controlling for firm's characteristics affect accounting policy and conservatism
include the proportion of intangible assets (𝐼𝑁𝑇𝐴𝑡−1) and goodwill (𝐺𝑊𝑡−1) in the total
assets. Together with 𝑅𝐷𝑡−1 , those variables are included to control for investment
uncertainty and growth opportunity. 𝑊𝐸𝐴𝐾𝑡 is a dummy variable, taking a value of one
if the firm experienced depressed stock performance or a decline in profitability during
the last fiscal year. It is supposed to control for the profitability and the nondiscretionary component in conservatism. 𝐷𝐸𝐵𝑇𝑡−1 , on the other hand, controls forcapital collected from open market where bond securities can be actively traded. I expectthat participants in this market, who might be exposed to more risks if the value of bondfluctuates, will closely follow the issuer’s activities and demands transparency.

4. Sample selection
The initial sample pool for Japanese listed firms consists of all listed firms on NIKKE
Financial Request. Stock return data from NPM Daily Return Database (Financial Data
Solutions). Companies with (a) fiscal year ending other than March; (b) missing data tocompute the measure of ASSET-BTM (i.e., and market capitalization or total assets); (c)with negative shareholders’ equity; (d) who had changed their year-end in the middle ofa fiscal year were excluded from the observations. To reduce analytical complexity,
financial institutions were also excluded from the analyses. The computation of
𝐶𝑂𝑁𝑆𝐾𝐸𝑊𝑡 reduces the sample size by 1457 observations in the GLM analysis.
Ownership-related data are manually collected from Quants Research issued by Toyo15

Keizai from the fiscal year 2003 to 2015.
Table 2 Process of Sample Selection
initial sample
30437

1 analytical complexity

Δ10492

2 required accounting data

Δ1502

3 negative common equity and asset write-downs

Δ25

4 required data for ownership

Δ163

total

18255

5. required cash flow data

Δ1457

subtotal

16798

5. Descriptive Statistics and Test Results
5.1 Descriptive Statistics
Table 3 reports the descriptive statistics of variables used in this study. A correlation
matrix for the variables, with Spearman correlations in the upper quadrant and Pearson
correlations in the lower quadrant is provided in Appendix 2. The regression results forcalculation of T_SCORE are provided in Appendix 3.
Panel A shows the proportion of shares owned by stable shareholders (𝑆𝑇𝐴𝐵𝐿𝐸𝑡−1 ) andforeign investors ( 𝐽. 𝐹𝑂𝑅𝐸𝐼𝐺𝑁𝑡−1 ), respectively. The median value for stableshareholdings (0.491) is lower than its mean value (0.505). A similar trend can beobserved for foreign shareholdings (mean 0.103 vs. median 0.062), indicating
concentration of ownership for companies in high percentiles. Pearson correlation
coefficient on foreign shareholdings (𝐽. 𝐹𝑂𝑅𝐸𝐼𝐺𝑁𝑡−1 ) with firm size (𝑆𝐼𝑍𝐸𝑡−1 ) is 0.669*.
These findings are consistent with evidence documented in Jiang and Kim [2004] that
foreign investors tend to choose companies with larger market capitalization.
Table 3 : Panel A
mean

p25

medianp75

sd

𝑆𝑇𝐴𝐵𝐿𝐸𝑡−1

0.505

0.391

0.491

0.616

0.150

𝐷. 𝑆𝑇𝐴𝐵𝐿𝐸

0.481

0.000

0.000

1.000

0.500

𝐽. 𝐹𝑂𝑅𝐸𝐼𝐺𝑁𝑡−1

0.103

0.013

0.062

0.160

0.113

𝐷. 𝐽𝐹𝑂𝑅𝐸𝐼𝐺𝑁𝑡−1

0.389

0.000

0.000

1.000

0.488

Notes:

16

𝑆𝑇𝐴𝐵𝐿𝐸𝑡−1 : the percentage of shares owned by the largest to the tenth-largest shareholders and other persons orcompanies affiliated with the company as defined in Quants Research. 𝐷. 𝑆𝑇𝐴𝐵𝐿𝐸𝑡−1 : a dummy variable takes thevalue of one if the proportion of stable shareholders is above the mean and zero otherwise. 𝐽. 𝐹𝑂𝑅𝐸𝐼𝐺𝑁𝑡−1 : thepercentage of shares owned by foreign individuals or institutions in Japan. 𝐷. 𝐽𝐹𝑂𝑅𝐸𝐼𝐺𝑁𝑡−1 : a dummy variable takes
the value of one if the proportion of foreign shareholders is above the mean and zero otherwise.

Panel B summarizes statistics for key variables employed in the analyses. The first

three variables are proposed by Basu [1997] to predict the level of accounting
conservatism. 𝐸𝑡 denotes the net income in fiscal year t deflated by market
capitalization measured at the end of fiscal year t. 𝑅𝑡 is the buy-and-hold return oncommon stock for the 12 months ending three months after the end of fiscal year t. 𝐷𝑅𝑡
is a dummy variable, taking a value of 1 if 𝑅𝑡 is negative, and zero otherwise. The meanvalue of 𝐷𝑅𝑡 is 0.554, indicating more Japanese firm experienced negative return acrossthe analysis period.
Table 3 : Panel B
mean

p25

median

p75

sd

𝐸𝑡

0.077

0.051

0.095

0.151

0.377

𝐷𝑅𝑡

0.554

0.000

1.000

1.000

0.497

𝑅𝑡

0.034

－0.182－0.030

0.135

2.400

𝐴𝐵𝑇𝑀𝑡−1

1.036

0.851

1.019

1.187

0.362

𝐵𝑇𝑀𝐷𝑡

0.530

0.000

1.000

1.000

0.499

ACCt

－0.033－0.060－0.032

0.004

0.070

∆𝐶𝐹𝑡

0.001

－0.027

0.001

0.031

0.134

𝐷∆𝐶𝐹𝑡

0.476

0.000

0.000

1.000

0.499

𝐶𝐿𝐸𝑉𝑀𝑉𝑡−1

0.023－0.068

0.000

0.079

3.920

𝑇_𝑆𝐶𝑂𝑅𝐸𝑡

0.130－0.043

0.097

0.239

0.371

𝐶𝑂𝑁𝑆𝐾𝐸𝑊𝑡

0.060－0.413

0.032

0.569

0.697

Notes:
𝐸𝑡 denotes the net income in fiscal year t deflated by market capitalization measured at the end of fiscal year t－1.
𝑅𝑡 : the buy-and-hold return on common stock for the twelve months ending three months after the end of fiscal year
t－1. 𝐷𝑅𝑡 : dummy variable, taking a value of 1 if 𝑅𝑡−1 is negative, and 0 otherwise. 𝐴𝐵𝑇𝑀𝑡−1 : total assets / market
capitalization + total assets －common equity, both measured at the end of fiscal year t－1. 𝐵𝑇𝑀𝐷t : a dummy
variable takes a value of 1 if 𝐴𝐵𝑇𝑀𝑡−1 is higher than 1 and 0 otherwise. 𝐴𝐶𝐶𝑡 : accruals in year t deflated by average
total assets. ∆𝐶𝐹𝑡 : changes in cash flows from operations deflated by average total assets. 𝐷∆𝐶𝐹𝑡 : a dummy variable,
taking the value of 1 if ∆𝐶𝐹𝑡 is negative and 0 otherwise. 𝐶𝐿𝐸𝑉𝑀𝑉t−1 : change in total liabilities deflated by beginningof-period market capitalization. 𝑇_𝑆𝐶𝑂𝑅𝐸𝑡 : a firm-year conservatism measure devised in Khan and Watts [2009].
𝐶𝑂𝑁𝑆𝐾𝐸𝑊𝑡 . the difference between the skewness of cash flows from operating activities and the skewness of net
income using a three-year rolling window.

𝐴𝐵𝑇𝑀𝑡−1 denotes ASSET-BTM measured at the end of fiscal year t－1, computed as the17book value of total assets deflated by the sum of market capitalization and total assets
minus common equity. Following is a dummy variable 𝐵𝑇𝑀𝐷t , which takes a value of 1
if 𝐴𝐵𝑇𝑀𝑡−1 is higher than 1 and 0 otherwise. More than half of Japanese firms havelower market values than their book values (𝐵𝑇𝑀𝐷𝑡 = 0.53).
Panel C presents the statistics for the control variables in this study. Firm size (𝑆𝐼𝑍𝐸)
and firm age (𝐴𝐺𝐸) are included as they are likely correlated with ownership structure
and information asymmetry. 𝐿𝐸𝑉𝑀𝑉𝑡−1 is calculated as book value of total liabilities
deflated by market value of common equity at the end of fiscal year t－1. 𝐷𝐸𝐵𝑇𝑡−1, on
the other hand, denotes proceeds from debt issuance deflated by market capitalization
at the end of fiscal year t－1. Public debt accounts for only about 9% of the total liabilities
in Japan. This is consistent with the discussion in Section 2 that banks play a much more
dominant role as a source of firm financing in Japan compared to the U.S.
Table 3: Panel C
mean

p25

medianp75

sd

𝐿𝐸𝑉𝑀𝑉𝑡−1

2.182

0.550

1.237

2.514

4.695

𝐷𝐸𝐵𝑇𝑡−1

0.005

0.000

0.000

0.000

0.022

𝑃𝑃𝐸𝑡−1

0.298

0.166

0.281

0.400

0.184

𝑆𝐼𝑍𝐸𝑡−1

10.102

8.885

9.943

11.2471.960

𝑙𝑛𝐴𝐺𝐸𝑡−1

4.086

3.951

4.220

4.369

0.491

Notes
𝐿𝐸𝑉𝑀𝑉𝑡−1 : book value of total liabilities deflated by market value of common equity at the end of fiscal year t－1.
𝐷𝐸𝐵𝑇𝑡−1 : proceeds from debt issuance deflated by market capitalization, both measured at the end of year t－1.
𝑃𝑃𝐸𝑡−1 : proportion of property, plant and equipment assets to total assets, measured at the end of year t－1. 𝑆𝐼𝑍𝐸𝑡−1 :the natural logarithm of market capitalization at the end of fiscal year t－1. 𝑙𝑛𝐴𝐺𝐸𝑡−1 : the natural logarithm of firmage.

5.2 Main Results
Table 4 presents main test results of the modified Basu model and assess theassociation between ownership structure and conservatism for Japanese listed firm. In
each panel, the first column presents the regression results for Model 1, which measures
the homogeneous effect of each ownership type across all firms. The third column
presents the regression results for Model 2, which examines effects of higher
concentration in ownership by replacing the proportion of shares by a dummy variable.
The estimations are performed using a fixed effects model. Estimates for interaction
terms on control variables are not shown for brevity. Two-tailed P-values are reported in
the apprentice.

18

5.2.1 Test Results for Modified Basu Model (Model 1)
Panel A reports test results for Japanese listed firms. As per H1, I posit that stableownership, which places importance on maintaining a long-term business ties with thefirm and the management, engenders lower demand for conservative accounting.
Consistent with my expectation, the coefficient on 𝐷𝑅𝑡 ∗ 𝑅𝑡 ∗ 𝑆𝑇𝐴𝐵𝐿𝐸𝑡−1 is significantly
negative for both model specifications (－0.559***), indicating that on average, the levelof conservatism decreases as the proportion of stable shareholders increases. In model 2,ownership proxy is replaced by a dummy variable, taking a value of one if the number ofstable shareholders is above the overall mean in the sample pool. As shown by the results,
the coefficient on 𝐷𝑅𝑡 ∗ 𝑅𝑡 ∗ 𝐷. 𝑆𝑇𝐴𝐵𝐿𝐸𝑡−1 is negative and statistically significant at the
1% level (－0.664***), suggesting that firms with larger stable shareholdings (above themean) become less timely in recognizing economic losses relative to economic gains.
On the other hand, under H3, I include the proportion of foreign investors to evidence
whether foreign ownership is associated with higher corporate transparency and lower
information asymmetry (e.g., Jiang and Kim [2004], Guo et al. [2015]). The results showthat the coefficient on 𝐷𝑅𝑡 ∗ 𝑅𝑡 ∗ 𝐽. 𝐹𝑂𝑅𝐸𝐼𝐺𝑁𝑡−1 is statistically positive and economicallyimportant compared to other control variables included in the model. For example, oneunit change in foreign ownership could drives loss recognition by almost the same value(0.971***). However, although estimate on

𝐷𝑅𝑡 ∗ 𝑅𝑡 ∗ 𝐽. 𝐹𝑂𝑅𝐸𝐼𝐺𝑁𝑡−1 in Model 2 ispositive, it lacks sufficient explanatory power (0.167). One possible explanation for the
reduced significance is the inclusion of the interaction term of 𝐷𝑅𝑡 ∗ 𝑅𝑡 ∗ 𝐴𝐵𝑇𝑀𝑡−1 ∗𝐷. 𝐽𝐹𝑂𝑅𝐸𝐼𝐺𝑁𝑡−1.
5.2.2 Test Results for Modified Basu Model (Model 2)
Model 2 also investigates how ownership structure affects levels of accounting
conservatism under different circumstances. First, with regards to the interaction term
between 𝐶𝐿𝐸𝑉𝑀𝑉𝑡−1 and 𝐷. 𝑆𝑇𝐴𝐵𝐿𝐸𝑡−1 , the coefficient is significantly negative ( －0.422***). As estimate for 𝐷𝑅𝑡 ∗ 𝑅𝑡 ∗ 𝐶𝐿𝐸𝑉𝑀𝑉𝑡−1 is insignificant (－0.237), it is uncertain
how change in leverage influence accounting conservatism. However, given thecoefficient on 𝐷𝑅𝑡 ∗ 𝑅𝑡 ∗ 𝐷. 𝑆𝑇𝐴𝐵𝐿𝐸𝑡−1 is significantly negative, it is reasonable to inferthat stable shareholdings either depresses timely loss recognition even when leveragecontinues to rise or provokes managerial discretion to avoid triggering debt covenants.
On the other hand, estimate for 𝐷𝑅𝑡 ∗ 𝑅𝑡 ∗ 𝐶𝐿𝐸𝑉𝑀𝑉𝑡−1 ∗ 𝐷. 𝐽𝐹𝑂𝑅𝐸𝐼𝐺𝑁𝑡−1 is positive andstatistically significant (0.120*). This again infers that foreign investors, when work on
their own, are less efficient in proving accounting quality. Finally, estimate for 𝐷𝑅𝑡 ∗𝑅𝑡 ∗ 𝐴𝐵𝑇𝑀𝑡−1 (0.233*) indicates a high level of regulatory effect in Japan. In the19meantime, estimates for 𝐷𝑅𝑡 ∗ 𝑅𝑡 ∗ 𝐴𝐵𝑇𝑀𝑡−1 ∗ 𝐷. 𝑆𝑇𝐴𝐵𝐿𝐸𝑡−1 and 𝐷𝑅𝑡 ∗ 𝑅𝑡 ∗ 𝐴𝐵𝑇𝑀𝑡−1 ∗𝐷. 𝐽𝐹𝑂𝑅𝐸𝐼𝐺𝑁𝑡−1 are both significantly positive (0.589*** and 0.305*). In other words,
non-discretionary conservatism is adequately effective to improve conservative
accounting in Japan. These test results reject H4 in this study, which predicts effects ofregulatory enforcement will be neutralized in view of a closely connected shareholding
structure.
Table 4 Test Results for Basu Model
Model 1𝑒𝑠𝑡𝑖𝑚𝑎𝑡𝑒𝑠

Model 2P − value𝑒𝑠𝑡𝑖𝑚𝑎𝑡𝑒𝑠

P − value𝐷𝑅𝑡 ∗ 𝑅𝑡

0.069

(0.510)0.221(0.078)𝐷𝑅𝑡 ∗ 𝑅𝑡 ∗ 𝐶𝐿𝐸𝑉𝑀𝑉𝑡−1

0.004(0.824)－0.237(0.099)𝐷𝑅𝑡 ∗ 𝑅𝑡 ∗ 𝐴𝐵𝑇𝑀𝑡−1

0.601***(0.000)0.233*(0.038)𝐷𝑅𝑡 ∗ 𝑅𝑡 ∗ 𝑆𝑇𝐴𝐵𝐿𝐸𝑡−1－0.559***(0.000)𝐷𝑅𝑡 ∗ 𝑅𝑡 ∗ 𝐷. 𝑆𝑇𝐴𝐵𝐿𝐸𝑡−1－0.664***(0.000)𝐷𝑅𝑡 ∗ 𝑅𝑡 ∗ 𝐶𝐿𝐸𝑉𝑀𝑉𝑡−1 ∗ 𝐷. 𝑆𝑇𝐴𝐵𝐿𝐸𝑡−1－0.422***(0.000)𝐷𝑅𝑡 ∗ 𝑅𝑡 ∗ 𝐴𝐵𝑇𝑀𝑡−1 ∗ 𝐷. 𝑆𝑇𝐴𝐵𝐿𝐸𝑡−1

0.589***(0.000)𝐷𝑅𝑡 ∗ 𝑅𝑡 ∗ 𝐷. 𝐽𝐹𝑂𝑅𝐸𝐼𝐺𝑁𝑡−1

0.167(0.163)𝐷𝑅𝑡 ∗ 𝑅𝑡 ∗ 𝐶𝐿𝐸𝑉𝑀𝑉𝑡−1 ∗ 𝐷. 𝐽𝐹𝑂𝑅𝐸𝐼𝐺𝑁𝑡−1

0.120*(0.031)𝐷𝑅𝑡 ∗ 𝑅𝑡 ∗ 𝐴𝐵𝑇𝑀𝑡−1 ∗ 𝐷. 𝐽𝐹𝑂𝑅𝐸𝐼𝐺𝑁𝑡−10.305*(0.017)𝐷𝑅𝑡 ∗ 𝑅𝑡 ∗ 𝐽. 𝐹𝑂𝑅𝐸𝐼𝐺𝑁𝑡−1

0.971***(0.000)𝐷𝑅𝑡 ∗ 𝑅𝑡 ∗ 𝑆𝐼𝑍𝐸𝑡−1－0.027***(0.000)－0.035***(0.000)intercept

0.534***(0.000)0.404***(0.000)

F

27.71

N

18255

29.19

Notes:
𝐸𝑡 denotes the net income in fiscal year t deflated by market capitalization measured at the end of fiscal year t－1.
𝑅𝑡−1 : the buy-and-hold return on common stock for the twelve months ending three months after the end of fiscal
year t－1. 𝐷𝑅𝑡 : dummy variable, taking a value of 1 if 𝑅𝑡−1 is negative, and 0 otherwise. 𝑆𝑇𝐴𝐵𝐿𝐸𝑡−1 : the percentageof shares owned by the largest to the tenth-largest shareholders and other persons or companies affiliated with thecompany. 𝐷. 𝑆𝑇𝐴𝐵𝐿𝐸𝑡−1 : a dummy variable takes the value of one if the proportion of stable shareholders is above
the mean and zero otherwise. 𝐽. 𝐹𝑂𝑅𝐸𝐼𝐺𝑁𝑡−1 : the percentage of shares owned by foreign individuals or institutionsin Japan. 𝐷. 𝐽𝐹𝑂𝑅𝐸𝐼𝐺𝑁𝑡−1 : a dummy variable takes the value of one if the proportion of foreign shareholders is above
the mean and zero otherwise. 𝐶𝐿𝐸𝑉𝑀𝑉t−1 is measured as the change in total liabilities deflated by beginning-ofperiod market capitalization. 𝐴𝐵𝑇𝑀𝑡−1 : total assets / market capitalization + total assets －common equity, bothmeasured at the end of fiscal year t－1. 𝑆𝐼𝑍𝐸𝑡−1 : the natural logarithm of market capitalization at the end of fiscal
year t－1. ***, **, * indicate significance at the two-tailed 1%, 5%, 10% confidence level, respectively.

In summary, test results in this section provide supports that stable shareholdings are20

negatively associated with accounting conservatism. Evidence in this section also
indicates that regulations in Japan is relatively more effective in facilitating accounting
conservatism. In the next section, a model selection technique is employed to determine
a more powerful predicting model with regards to the combined effects of the factors
discussed in this section.

5.2.3 Test Results for GLM-SELECTThis section presents test results for general linear model selection (GLM-SELECT
hereafter) which detect the relationship between firm level conservatism and ownership
structure. In order to reduce the selection bias, the adaptive least absolute shrinkage
and selection operator (LASSO) is implemented as the selection method ( Tibshirani[1996] and Wu and Liu [2009]). It allows predictors to enter or leave the model
individually, through which only non-zero parameters would be retained in the model. I
applied the Adjusted R-square statistic (𝐴𝑑𝑗. 𝑅 2), Akaike’s information criterion (𝐴𝐼𝐶),
Corrected Akaike’s information criterion ( 𝐴𝐼𝐶𝐶 ) and Bayesian information criterion(𝐵𝐼𝐶)/ Schwarz Bayesian information criterion (𝑆𝐵𝐶) to evaluate the quality of the models
produced by GLM-SELECT. In all the tests, 𝐵𝐼𝐶 / 𝑆𝐵𝐶 introduces a much stronger
penalty over the other criterion.
Figure 1 reports the selection process. The upper plots show how the model evolves
through the selection process. Each colored line represents the value taken by a different
variable. The vertical axis reveals the fit statistics of the variables and assesses therelative importance of the effects selected at any step of the selection process. The
horizontal axis provides information as to when effects of the selected variables enter
the model. The lower plot in the panel shows the stopping criterion used to choose themodel and how it changes as variables enter or leave the model. The vertical gray line
connecting the upper plot and the lower plot indicates the maximum number of steps,
which when reached, denotes the termination of the selection process. The effects chosen
by then are viewed as the optimal model to explain the response variable.
Table 5 reports the test results for ordinary least square regression based on theoriginal model (OLS model hereafter) and the model determined by GLM-SELECT (GLM
model hereafter). Estimates on control variables are not reported for brevity. It should
be noted that careful attention is needed on interpretation of test results in this section
due to measurement error with regards to the dependent variables (𝑇_𝑆𝐶𝑂𝑅𝐸𝑡 and𝐶𝑂𝑁𝑆𝐾𝐸𝑊𝑡 ) applied in the model.

215.2.3.1 Test Results for Model 3
Panels A and B in Table 5 report test results for models chosen by GLM-SELECT. H1
predicts that stable shareholdings generate a lower demand for accounting conservatism.
Estimate for 𝑆𝑇𝐴𝐵𝐿𝐸𝑡−1 is significantly negative ( － 0.176***) in the CONSKEW
specification. This is consistent with the prediction in this study that higher proportionof stable shareholdings reduces bad news sensitivity. On the other hand, sign on
𝐶𝐿𝐸𝑉𝑀𝑉𝑡−1 is statically positive in the OLS model (0.032***), indicating that leverage
serves as a primary driver for conservatism. Moreover, consistent with the expectationin this study, coefficients on 𝐶𝐿𝐸𝑉𝑀𝑉𝑡−1 ∗ 𝑆𝑇𝐴𝐵𝐿𝐸𝑡−1

are significantly negative in the

OLS model and the GLM model (－0.067*** and －0.025***). This implies that despite
the existence of increased needs for conservatism, earnings are still prone to be lessresponsive to bad news in the presence of high stable shareholdings, which offer supports
for H2.
Under H4, I also predict that a weakening enforcement environment will fail to improve
accounting quality which manifests as a negative association between the measure
𝐴𝐵𝑇𝑀𝑡−1 and the dependent variables. Sign on the interaction term 𝐴𝐵𝑇𝑀𝑡−1 ∗𝑆𝑇𝐴𝐵𝐿𝐸𝑡−1 is 0.084*** in the T_SCORE specification. This result holds when thedependent variable changes to CONSKEW, where coefficient on 𝐴𝐵𝑇𝑀𝑡−1 ∗ 𝑆𝑇𝐴𝐵𝐿𝐸𝑡−1 isalso statistically positive (0.061*), suggesting that negative effects of stableshareholdings are offset when assets are over evaluated. These results again reject H4for Japanese listed firms.
This study also predicts that foreign investors do not necessarily promote accounting
conservatism and spur changes in accounting practices. However, sign on the individual
effect of 𝐹𝑂𝑅𝐸𝐼𝐺𝑁𝑡−1 lacks sufficient explanatory power in both of the T_SCORE andCONSKEW specifications, thereby influence of foreign investors are inconclusive in thistest. Nonetheless, the interaction term of 𝐴𝐵𝑇𝑀𝑡−1 ∗ 𝐹𝑂𝑅𝐸𝐼𝐺𝑁𝑡−1 is significantly
positive and is included in the model (0.243***), implying that foreign investors are morevigilant in asset overvaluation and assist in accounting conservatism.
Findings in this section are similar with those in the previous section with regards tothe cross effects between debt contracting and foreign equity. Coefficient on 𝐶𝐿𝐸𝑉𝑀𝑉𝑡−1 ∗𝐽. 𝐹𝑂𝑅𝐸𝐼𝐺𝑁𝑡−1 is significantly positive in both specifications (0.088*** and 0.009**) while
the individual effect of 𝐽. 𝐹𝑂𝑅𝐸𝐼𝐺𝑁𝑡−1 is not statistically significant and excluded fromthe model. This again implies that effects of foreign investors alone are not enough tomake an impact in conventional accounting practices.
To sum, findings in this section offer support for H1 that stable ownership depresses
accounting conservatism in Japan even when circumstance (change in leverage) predicts
22the opposite. H4 is rejected as the interaction term with 𝐴𝐵𝑇𝑀 ratio for stableshareholdings is significantly positive. No significant evidence is found to explain effects
of foreign shareholdings on accounting conservatism in this analysis. Prior studies
suggest that the involvement of foreign investors in corporate governance practice canbe an effective way to lower agency cost. However, based on test results in this test,
foreign investors, despite their expertise and experience, may still play a secondary rolein corporate monitoring as they still lack opportunity to observe day-to-day accounting
practices.

23

Figure 1:
Coefficient Progression: CONSKEW

Coefficient Progression: T_SCORE

Notes:
𝑇_𝑆𝐶𝑂𝑅𝐸𝑡 : a firm-year conservatism measure devised in Khan and Watts [2009]. 𝐶𝑂𝑁𝑆𝐾𝐸𝑊𝑡 . the difference between the skewness of cash flows from operating activities and theskewness of net income using a three-year rolling window. 𝑆𝑇𝐴𝐵𝐿𝐸𝑡−1 : the percentage of shares owned by the largest to the tenth-largest shareholders and other persons orcompanies affiliated with the company as defined in Quants Research. 𝐽. 𝐹𝑂𝑅𝐸𝐼𝐺𝑁𝑡−1 : the percentage of shares owned by foreign individuals or institutions in Japan. 𝐶𝐿𝐸𝑉𝑀𝑉t−1
is measured as the change in total liabilities deflated by beginning-of-period market capitalization. 𝐴𝐵𝑇𝑀𝑡−1 : total assets / market capitalization + total assets －common equity,
both measured at the end of fiscal year t－1. 𝑆𝐼𝑍𝐸𝑡−1 : the natural logarithm of market capitalization at the end of fiscal year t－1. 𝑃𝑃𝐸𝑡−1 : proportion of property, plant andequipment assets to total assets, measured at the end of year t－1. 𝐷𝐸𝐵𝑇𝑡−1 : proceeds from debt issuance deflated by market capitalization, both measured at the end of year t－
1. 𝑙𝑛𝐴𝐺𝐸𝑡−1 : the natural logarithm of firm age. 𝑊𝐸𝐴𝐾𝑡 : a dummy variable takes the value of 1 if 𝐿𝑅𝑂𝐴𝑡 or 𝐿𝑅𝑡 is below 5% and 0 otherwise. 𝐿𝑅𝑂𝐴t is a lag indicator for 𝑅𝑂𝐴,
computed as the average value of 𝑅𝑂𝐴𝑡−1 and 𝑅𝑂𝐴𝑡−2. 𝐿𝑅𝑡 is a lag indicator for 𝑅𝑂𝐴, computed as the average value of 𝑅𝑡−1 and 𝑅𝑡−2 . 𝑅𝑂𝐴𝑡 is measured as income before
extraordinary items deflated by book value of total assets, both measured at the end of fiscal year t. 𝑅𝑡 is the buy-and-hold return on common stock for the twelve months ending
three months after the end of fiscal year t. 𝐺𝑊𝑡−1 : book value of goodwill deflated by total assets, both measured at the end of fiscal year t－1. 𝐼𝑁𝑇𝐴𝑡−1 : book value of intangible
assets deflated by total assets, both measured at the end of fiscal year t－1. 𝑅𝐷𝑡−1 . expenditure on research and development deflated by total sales, both measured at the end of
fiscal year t－1.

24Model 3:
𝑇_𝑆𝐶𝑂𝑅𝐸𝑡 (𝐶𝑂𝑁𝑆𝐾𝐸𝑊𝑡 ) = 𝛼0 + 𝛼1 𝐶𝐿𝐸𝑉𝑀𝑉𝑡−1 + 𝜶𝟐 𝐴𝐵𝑇𝑀𝑡−1 + 𝛼3 𝑆𝑇𝐴𝐵𝐿𝐸𝑡−1 + 𝛼4 𝐶𝐿𝐸𝑉𝑀𝑉𝑡−1 ∗ 𝑆𝑇𝐴𝐵𝐿𝐸𝑡−1 + 𝛼5 𝐴𝐵𝑇𝑀𝑡−1 ∗ 𝑆𝑇𝐴𝐵𝐿𝐸𝑡−1 + 𝛼6 𝐽. 𝐹𝑂𝑅𝐸𝐼𝐺𝑁𝑡−1 +𝛼7 𝐶𝐿𝐸𝑉𝑀𝑉𝑡−1 ∗ 𝐽. 𝐹𝑂𝑅𝐸𝐼𝐺𝑁𝑡−1 + 𝛼8 𝐴𝐵𝑇𝑀𝑡−1 ∗ 𝐽. 𝐹𝑂𝑅𝐸𝐼𝐺𝑁𝑡−1 + 𝑐𝑜𝑛𝑡𝑟𝑜𝑙𝑠 + 𝜀𝑡
Table 5 Test Results for GLM-SELECT
Panel A : T_SCOREt
OLS
𝑒𝑠𝑡𝑖𝑚𝑎𝑡𝑒𝑠

GLM
P − value𝑒𝑠𝑡𝑖𝑚𝑎𝑡𝑒𝑠

P − value

𝐶𝐿𝐸𝑉𝑀𝑉𝑡−1?

0.032***(0.000)

𝐴𝐵𝑇𝑀𝑡−1+－0.089**(0.002)𝑆𝑇𝐴𝐵𝐿𝐸𝑡−1－－0.027(0.607)

𝐶𝐿𝐸𝑉𝑀𝑉𝑡−1 ∗ 𝑆𝑇𝐴𝐵𝐿𝐸𝑡−1－－0.067***(0.000)－0.025***(0.000)

𝐴𝐵𝑇𝑀𝑡−1 ∗ 𝑆𝑇𝐴𝐵𝐿𝐸𝑡−1－－0.015(0.748)0.084***(0.000)𝐽. 𝐹𝑂𝑅𝐸𝐼𝐺𝑁𝑡−1

－

0.182

(0.059)

𝐶𝐿𝐸𝑉𝑀𝑉𝑡−1 ∗ 𝐽. 𝐹𝑂𝑅𝐸𝐼𝐺𝑁𝑡−1

－

0.028

(0.160)0.088***(0.000)

𝐴𝐵𝑇𝑀𝑡−1 ∗ 𝐽. 𝐹𝑂𝑅𝐸𝐼𝐺𝑁𝑡−1－

0.249***(0.000)0.243***(0.000)𝑖𝑛𝑡𝑒𝑟𝑐𝑒𝑝𝑡

1.223***(0.000)0.128***(0.000)Adj − R2

0.266

𝑁

18255

0.130

Notes:
𝑇_𝑆𝐶𝑂𝑅𝐸𝑡 : a firm-year conservatism measure devised in Khan and Watts [2009]. 𝑆𝑇𝐴𝐵𝐿𝐸𝑡−1 : the percentage of shares owned by the largest to the tenth-largest shareholders andother persons or companies affiliated with the company as defined in Quants Research. 𝐽. 𝐹𝑂𝑅𝐸𝐼𝐺𝑁𝑡−1 : the percentage of shares owned by foreign individuals or institutions inJapan. 𝐶𝐿𝐸𝑉𝑀𝑉t−1 is measured as the change in total liabilities deflated by beginning-of-period market capitalization. 𝐴𝐵𝑇𝑀𝑡−1 : total assets / market capitalization + total assets－common equity, both measured at the end of fiscal year t－1. ***, **, * indicate significance at the two-tailed 1%, 5%, 10% confidence level, respectively.

25

Table 5 Test Results for GLM-SELECT
Panel B : 𝐶𝑂𝑁𝑆𝐾𝐸𝑊t
OLS𝑒𝑠𝑡𝑖𝑚𝑎𝑡𝑒𝑠

GLM
P − value

𝐶𝐿𝐸𝑉𝑀𝑉𝑡−1?

－0.025(0.204)

𝐴𝐵𝑇𝑀𝑡−1+

0.085(0.184)

𝑆𝑇𝐴𝐵𝐿𝐸𝑡−1－－0.074***(0.000)

𝐶𝐿𝐸𝑉𝑀𝑉𝑡−1 ∗ 𝑆𝑇𝐴𝐵𝐿𝐸𝑡−1

－

0.015

(0.627)

𝐴𝐵𝑇𝑀𝑡−1 ∗ 𝑆𝑇𝐴𝐵𝐿𝐸𝑡−1

－

0.084

(0.432)

𝐽. 𝐹𝑂𝑅𝐸𝐼𝐺𝑁𝑡−1－－0.171(0.272)

𝐶𝐿𝐸𝑉𝑀𝑉𝑡−1 ∗ 𝐽. 𝐹𝑂𝑅𝐸𝐼𝐺𝑁𝑡−1

－

0.069

(0.125)

𝐴𝐵𝑇𝑀𝑡−1 ∗ 𝐽. 𝐹𝑂𝑅𝐸𝐼𝐺𝑁𝑡−1

－

0.169

(0.277)

𝑖𝑛𝑡𝑒𝑟𝑐𝑒𝑝𝑡

0.148(0.109)Adj − R2

0.003

𝑁

16798

𝑒𝑠𝑡𝑖𝑚𝑎𝑡𝑒𝑠

P − value－0.002**(0.009)－0.176***(0.000)0.061*(0.028)0.009**(0.009)0.201***(0.000)0.003

Notes:𝐶𝑂𝑁𝑆𝐾𝐸𝑊𝑡 . the difference between the skewness of cash flows from operating activities and the skewness of net income using a three-year rolling window. 𝑆𝑇𝐴𝐵𝐿𝐸𝑡−1 : thepercentage of shares owned by the largest to the tenth-largest shareholders and other persons or companies affiliated with the company as defined in Quants Research.
𝐽. 𝐹𝑂𝑅𝐸𝐼𝐺𝑁𝑡−1 : the percentage of shares owned by foreign individuals or institutions in Japan. 𝐶𝐿𝐸𝑉𝑀𝑉t−1 : the change in total liabilities deflated by beginning-of-period market
capitalization. 𝐴𝐵𝑇𝑀𝑡−1 : total assets / market capitalization + total assets －common equity, both measured at the end of fiscal year t－1. ***, **, * indicate significance at the twotailed 1%, 5%, 10% confidence level, respectively.

26

6. Additional Test
6.1 Accrual Model
As a final test, I employed a modified accrual model to examine the degree of conditional
conservatism in this section. In line with Basu [1997], Ball and Shivakumar [2006] argue
that conservatism also induces asymmetry in the timeliness of gain and loss accrualrecognition in which operating cash flows indicate the bad news and the good news.
According to their framework, a decline in operating cash flows, more often than not,indicates a reduction in the asset’s value (bad news). Hence, loss accruals should be
captured in a timelier manner as conservatism requires management to reflect suchvalue deterioration at the time the information arises.
ACCt = 𝛼0 + 𝛼1 𝐷∆𝐶𝐹t + 𝛼2 ∆𝐶𝐹𝑡 + 𝛼3 𝐷∆𝐶𝐹t ∗ ∆𝐶𝐹t + 𝛼4 ∆𝑅𝐸𝑉𝑡 + α5 𝐺𝑃𝑃𝐸 + 𝜀𝑡

Eq.2

where ACCt denotes accruals in year t. 4 ∆𝐶𝐹𝑡 denotes changes in cash flows fromoperations taken form the cash flow statement. 𝐷∆𝐶𝐹𝑡 is a dummy variable, taking thevalue of 1 if ∆𝐶𝐹𝑡 is negative and zero otherwise. ∆𝑅𝐸𝑉𝑡 denotes changes in net sales inyear t. 𝐺𝑃𝑃𝐸𝑡 denotes gross property, plant, and equipment. The variables are alldeflated by average total assets in year t. As in Jones model, changes in sales control for
non-discretionary accruals of current assets and liabilities, while property, plant andequipment control for the non-discretionary component of depreciation expenses. Again,
as with Basu [1997], 𝐷∆𝐶𝐹t ∗ ∆𝐶𝐹t measures the extent to which firms are conservative.
Under conservative reporting, 𝐷∆𝐶𝐹t ∗ ∆𝐶𝐹t is expected to be positive. Following García
Lara et al. [2009] and Haw et al. [2014], I incorporate both the main effect variables andtheir interaction terms into the base-line accrual model to examine the relationshipbetween ownership structure and the level of accounting conservatism .
Model 4:
ACCt = 𝛼0 + 𝛼1 𝐷∆𝐶𝐹𝑡 + 𝛼2 ∆𝐶𝐹t + 𝛼3 𝐷∆𝐶𝐹t ∗ ∆𝐶𝐹t + 𝛼4 𝐷. 𝑋𝑡−1 + 𝛼5 𝐷∆𝐶𝐹𝑡 ∗ 𝐷. 𝑋𝑡−1 + 𝛼6 ∆𝐶𝐹t ∗ 𝐷. 𝑋𝑡−1 + 𝛼7 𝐷∆𝐶𝐹t ∗∆𝐶𝐹t ∗ 𝑋𝑡−1 + 𝛼8 𝐶𝐿𝐸𝑉𝑀𝑉𝑡−1 + 𝛼9 𝐷∆𝐶𝐹𝑡 ∗ 𝐶𝐿𝐸𝑉𝑀𝑉𝑡−1 + 𝛼10 ∆𝐶𝐹t ∗ 𝐶𝐿𝐸𝑉𝑀𝑉𝑡−1 + α11 𝐷∆𝐶𝐹𝑡 ∗ ∆𝐶𝐹t ∗ 𝐶𝐿𝐸𝑉𝑀𝑉𝑡−1 +𝛼12 𝐴𝐵𝑇𝑀𝑡−1 + 𝛼13 𝐷∆𝐶𝐹𝑡 ∗ 𝐴𝐵𝑇𝑀𝑡−1 + α14 ∆𝐶𝐹t ∗ 𝐴𝐵𝑇𝑀𝑡−1 + 𝛼15 𝐷∆𝐶𝐹𝑡 ∗ ∆𝐶𝐹t ∗ 𝐴𝐵𝑇𝑀𝑡−1 + 𝛼16 𝐶𝐿𝐸𝑉𝑀𝑉𝑡−1 ∗ 𝐷. 𝑋𝑡−1 +𝛼17 𝐷∆𝐶𝐹𝑡 ∗ 𝐶𝐿𝐸𝑉𝑀𝑉𝑡−1 ∗ 𝐷. 𝑋𝑡−1 + α18 ∆𝐶𝐹t ∗ 𝐶𝐿𝐸𝑉𝑀𝑉𝑡−1 ∗ 𝐷. 𝑋𝑡−1 + 𝛼19 𝐷∆𝐶𝐹𝑡 ∗ ∆𝐶𝐹t ∗ 𝐶𝐿𝐸𝑉𝑀𝑉𝑡−1 ∗ 𝐷. 𝑋𝑡−1 +Following Kothari et al. [2005], accruals in year t are measured based on the following equation:
𝐴𝐶𝐶𝑡 ＝∆𝐶𝐴𝑡 － ∆𝐶𝑎𝑠ℎ𝑡 － (∆𝐶𝐿𝑡 － ∆𝑆𝑇𝐷𝑡 ) － 𝐷𝑒𝑝𝑡∆𝐶𝐴𝑡
: change in current assets∆𝐶𝑎𝑠ℎ𝑡 : change in cash and cash equivalents∆𝐶𝐿𝑡: change in current liabilities∆𝑆𝑇𝐷𝑡 : change in current liabilities transformed from non-current liabilities
𝐷𝑒𝑝𝑡: depreciation expenses
427𝛼20 𝐴𝐵𝑇𝑀𝑡−1 ∗ 𝐷. 𝑋𝑡−1 + 𝛼21 𝐷∆𝐶𝐹𝑡 ∗ 𝐴𝐵𝑇𝑀𝑡−1 ∗ 𝐷. 𝑋𝑡−1 + 𝛼22 ∆𝐶𝐹t ∗ 𝐴𝐵𝑇𝑀𝑡−1 ∗ 𝐷. 𝑋𝑡−1 + 𝛼23 𝐷∆𝐶𝐹𝑡 ∗ ∆𝐶𝐹t ∗ 𝐴𝐵𝑇𝑀𝑡−1 ∗𝐷. 𝑋𝑡−1 + 𝛼24 ∆𝑅𝐸𝑉𝑡 + 𝛼25 𝐺𝑃𝑃𝐸𝑡 + 𝑦𝑒𝑎𝑟 𝑓𝑖𝑥𝑒𝑑 𝑒𝑓𝑓𝑒𝑐𝑡𝑠 + 𝑖𝑛𝑑𝑢𝑠𝑟𝑡𝑦 𝑓𝑖𝑥𝑒𝑑 𝑒𝑓𝑓𝑒𝑐𝑡𝑠 + 𝜀𝑡

In model 4, 𝐷. 𝑋𝑡−1 divides samples into two groups with different level ofconcentration in each ownership structure. 𝐷. 𝑆𝑇𝐴𝐵𝐿𝐸t−1 and 𝐷. 𝐽𝐹𝑂𝑅𝐸𝐼𝐺𝑁t−1 takes
the value of one if the proportion of stable ownership or foreign ownership is above theirmeans, respectively.
According to H1, I expect that the presence of stable shareholders will reduce thedemand for timelier loss recognition, therefore the predicted sign for𝐷∆𝐶𝐹t ∗ ∆𝐶𝐹t ∗𝐷. 𝑆𝑇𝐴𝐵𝐿𝐸𝑡−1 is negative. In a similar vein, I expect that influence of foreign investors
would be weaker due to the unique institutional environment in Japan.
Table 6 summarizes the test results for the modified accrual model. With regard to H1
in this study, the anticipated sign on the primary variable of interest, 𝐷. 𝑆𝑇𝐴𝐵𝐿𝐸𝑡−1 isnegative. However, estimate on 𝐷∆𝐶𝐹t ∗ ∆𝐶𝐹t ∗ 𝑆𝑇𝐴𝐵𝐿𝐸𝑡−1 is significantly positive(0.337***), which differs with test results in the modified Basu models (coefficient on
DRt ∗ 𝑅𝑡 ∗ 𝑆𝑇𝐴𝐵𝐿𝐸𝑡−1 and DR t ∗ 𝑅𝑡 ∗ 𝑆𝑇𝐴𝐵𝐿𝐸𝑡−1 is significantly negative (－0.025*** and－0.007*)). One possible explanation of the observed change in sign and significance on
stable shareholdings (𝑆𝑇𝐴𝐵𝐿𝐸𝑡−1 ) in the accrual-based model could be interpreted as
effects of a developed regulatory infrastructure in Japan and management’s deviationfrom accrual management. It is consistent with the conjectures made in Cohen et al.
[2008] and Cohen and Zarowin [2010] that accrual-based earnings management iscostlier and much easier to be detected by auditors. Therefore, results in Table 6 could
not entirely reject H1 in that firms could still delay loss recognition in non-cash-basedtransactions (i.e., asset impairment losses). Turning to foreign shareholdings, sign on
the dummy variable 𝐷. 𝐽𝐹𝑂𝑅𝐸𝐼𝐺𝑁𝑡−1 is －0.551, suggesting that higher proportion offoreign investors does not necessarily lead to higher commitment to conservatism. As an
additional test, I also replace the main effect to adjusted foreign ownership(𝐴. 𝐽𝐹𝑂𝑅𝐸𝐼𝐺𝑁𝑡−1 ) 5 suggested in Jiang and Kim [2004]. It measures the proportion offoreign equity ownership relative to that of stable ownership. Estimate for
𝐴. 𝐽𝐹𝑂𝑅𝐸𝐼𝐺𝑁𝑡−1 is 0.056*** (P − value = 0.000). This result shows that foreign investors
5 Adjusted foreign ownership (𝐴. 𝐽𝐹𝑂𝑅𝐸𝐼𝐺𝑁 ) is measured as follows:
𝑡−1

𝐴. 𝐽𝐹𝑂𝑅𝐸𝐼𝐺𝑁𝑡−1 = 𝐽. 𝐹𝑂𝑅𝐸𝐼𝐺𝑁𝑡−1 /(1 − 𝑆𝑇𝐴𝐵𝐿𝐸𝑡−1 )where:
𝐽. 𝐹𝑂𝑅𝐸𝐼𝐺𝑁𝑡−1 : the percentage of shares owned by foreign individuals or institutions in Japan.
𝑆𝑇𝐴𝐵𝐿𝐸𝑡−1 : the percentage of shares owned by the largest to the tenth-largest shareholders and other persons orcompanies affiliated with the company.

28

are more likely to actively prompt accounting conservatism in firms whose proportion of
stable ownership is relatively lower.
H2 predicts that creditors do not sufficiently facilitate accounting conservatism asownership concentration intensifies among a close network of shareholders in Japan.
Estimate for 𝐷∆𝐶𝐹𝑡 ∗ ∆𝐶𝐹t ∗ 𝐶𝐿𝐸𝑉𝑀𝑉𝑡−1 is negative and statistically significant ( －0.080***), suggesting that the level of conservatism decreases when leverage is higher
than the previous accounting period. The negative impact comes from the cross effect ofdebt contracting and stable shareholdings (𝐷∆𝐶𝐹𝑡 ∗ ∆𝐶𝐹t ∗ 𝐶𝐿𝐸𝑉𝑀𝑉𝑡−1 ∗ 𝐷. 𝑆𝑇𝐴𝐵𝐿𝐸𝑡−1=－
0.071***) could be attributed to management’s incentives to avoid inflated financial
leverage when the proportion of stable shareholdings grows higher. In conclusion, theaccrual model provides additional evidence for H2. On the other hand, sign on 𝐷∆𝐶𝐹𝑡 ∗∆𝐶𝐹t ∗ 𝐴𝐵𝑇𝑀𝑡−1 is positive and significant at the 1% level (0.676***), implying a soundenforcement effects of accounting standards. Moreover, estimate for 𝐷∆𝐶𝐹𝑡 ∗ ∆𝐶𝐹t ∗𝐴𝐵𝑇𝑀𝑡−1 ∗ 𝐷. 𝑆𝑇𝐴𝐵𝐿𝐸𝑡−1 is also statistically positive (0.419***). When compared with theestimate for 𝐷∆𝐶𝐹𝑡 ∗ ∆𝐶𝐹t ∗ 𝐷. 𝑆𝑇𝐴𝐵𝐿𝐸𝑡−1 (0.337***), the increased economic importancecould be attributed to the inclusion of 𝐴𝐵𝑇𝑀𝑡−1 . This shows that non-discretionary
conservatism has an incremental positive effect on accounting conservatism, which isconsistent with evidence found in the modified Basu model (𝐴𝐵𝑇𝑀𝑡−1 ∗ 𝐷. 𝑆𝑇𝐴𝐵𝐿𝐸𝑡−1 =0.589***) and GLM-SELCET analysis (𝐴𝐵𝑇𝑀𝑡−1 ∗ 𝐷. 𝑆𝑇𝐴𝐵𝐿𝐸𝑡−1 = 0.084*** and 0.061*)
and rejects H4 proposed in Section 3.1.
Turning to cross effects for foreign shareholdings in Table 6, the coefficient on 𝐷∆𝐶𝐹𝑡 ∗∆𝐶𝐹t ∗ 𝐶𝐿𝐸𝑉𝑀𝑉𝑡−1 ∗ 𝐷. 𝐽𝐹𝑂𝑅𝐸𝐼𝐺𝑁𝑡−1 is significantly negative (－0.131 ***) in the accrualmodel. This is different with findings in the previous sections wherein the coefficient on
𝐶𝐿𝐸𝑉𝑀𝑉𝑡−1 ∗ 𝐷. 𝐽𝐹𝑂𝑅𝐸𝐼𝐺𝑁𝑡−1 is significantly positive (0.120* in the modified Basumodel; 0.088*** in the GLM − T_SCORE specification and 0.009** in the GLM −CONSKEW specification). 6 The change in the sign on 𝐷∆𝐶𝐹𝑡 ∗ ∆𝐶𝐹t ∗ 𝐶𝐿𝐸𝑉𝑀𝑉𝑡−1 ∗6 To exclude the possibility that the change in sign on 𝐶𝐿𝐸𝑉𝑀𝑉

𝑡−1 and 𝐶𝐿𝐸𝑉𝑀𝑉𝑡−1 ∗ 𝐷. 𝐽𝐹𝑂𝑅𝐸𝐼𝐺𝑁𝑡−1 isdue to measurement error (use of different deflater), I replaced 𝐶𝐿𝐸𝑉𝑀𝑉𝑡−1 and 𝐴𝐵𝑇𝑀𝑡−1 with twodummy variables, i.e., 𝑇𝑟. 𝐶𝐿𝐸𝑉𝑀𝑉t and 𝐵𝑇𝑀𝐷𝑡 using the model specification shown below. Test
results show that the sign on 𝐶𝐿𝐸𝑉𝑀𝑉𝑡−1 is positive but is not statistically significant (0.029, P − value= 0.61) while that on 𝐶𝐿𝐸𝑉𝑀𝑉𝑡−1 ∗ 𝐷. 𝐽𝐹𝑂𝑅𝐸𝐼𝐺𝑁𝑡−1 is insignificantly negative (－0.018, P − value =0.776). I also replace the 𝐷. 𝐽𝐹𝑂𝑅𝐸𝐼𝐺𝑁𝑡−1 with 𝐷. 𝐴𝐽𝐹𝑂𝑅𝐸𝐼𝐺𝑁𝑡−1 , which is a dummy variable takes thevalue of one if 𝐷. 𝐴𝐽𝐹𝑂𝑅𝐸𝐼𝐺𝑁𝑡−1 (the relative proportion of foreign equity against stable shareholdings)
is above its mean value. The estimate remains significantly negative (－0.110***). Furthermore, test
results produced by the following model do not change the core findings in this study.

ACCt = 𝛼0 + 𝛼1 𝐷∆𝐶𝐹𝑡 + 𝛼2 ∆𝐶𝐹t + 𝛼3 𝐷∆𝐶𝐹t ∗ ∆𝐶𝐹t + 𝛼4 𝑋𝑡−1 + 𝛼5 𝐷∆𝐶𝐹𝑡 ∗ 𝑋𝑡−1 + 𝛼6 ∆𝐶𝐹t ∗ 𝑋𝑡−1 +𝛼7 𝐷∆𝐶𝐹t ∗ ∆𝐶𝐹t ∗ 𝑋𝑡−1 + 𝛼8 𝑇𝑟. 𝐶𝐿𝐸𝑉𝑀𝑉𝑡−1 + 𝛼9 𝐷∆𝐶𝐹𝑡 ∗ 𝑇𝑟. 𝐶𝐿𝐸𝑉𝑀𝑉𝑡−1 + 𝛼10 ∆𝐶𝐹t ∗ 𝑇𝑟. 𝐶𝐿𝐸𝑉𝑀𝑉𝑡−1 +α11 𝐷∆𝐶𝐹𝑡 ∗ ∆𝐶𝐹t ∗ 𝑇𝑟. 𝐶𝐿𝐸𝑉𝑀𝑉𝑡−1 + 𝛼12 𝐵𝑇𝑀𝐷𝑡 + 𝛼13 𝐷∆𝐶𝐹𝑡 ∗ 𝐵𝑇𝑀𝐷𝑡 + α14 ∆𝐶𝐹t ∗ 𝐵𝑇𝑀𝐷𝑡 + 𝛼15 𝐷∆𝐶𝐹𝑡 ∗∆𝐶𝐹t ∗ 𝐵𝑇𝑀𝐷𝑡 + 𝛼16 𝑇𝑟. 𝐶𝐿𝐸𝑉𝑀𝑉𝑡−1 ∗ 𝑋𝑡−1 + 𝛼17 𝐷∆𝐶𝐹𝑡 ∗ 𝑇𝑟. 𝐶𝐿𝐸𝑉𝑀𝑉𝑡−1 ∗ 𝑋𝑡−1 + α18 ∆𝐶𝐹t ∗29

𝐷. 𝐽𝐹𝑂𝑅𝐸𝐼𝐺𝑁𝑡−1 could be attributed to the downward impact of leverage, but it also
indirectly implies that a higher proportion of foreign equity does not contribute to higher
level of conservative accounting.
On the other hand, the positive estimate on 𝐷∆𝐶𝐹𝑡 ∗ ∆𝐶𝐹t ∗ 𝐴𝐵𝑇𝑀𝑡−1 ∗ 𝐷. 𝐽𝐹𝑂𝑅𝐸𝐼𝐺𝑁𝑡−1
is significantly positive (0.493***). It could be considered as the power of regulatory
enforcement. This evidence provides additional evidence on the importance of regulatoryenvironments on accounting quality.
Table 6 Test Results for Accrual Model𝐷∆𝐶𝐹t ∗ ∆𝐶𝐹t

0.471***(0.000)𝐷∆𝐶𝐹𝑡 ∗ ∆𝐶𝐹t ∗ 𝐶𝐿𝐸𝑉𝑀𝑉𝑡−1－0.080*(0.011)

𝐷∆𝐶𝐹𝑡 ∗ ∆𝐶𝐹t ∗ 𝐴𝐵𝑇𝑀𝑡−1

0.676***(0.000)𝐷∆𝐶𝐹𝑡 ∗ ∆𝐶𝐹t ∗ 𝐷. 𝑆𝑇𝐴𝐵𝐿𝐸𝑡−1

0.337***(0.000)𝐷∆𝐶𝐹𝑡 ∗ ∆𝐶𝐹t ∗ 𝐶𝐿𝐸𝑉𝑀𝑉𝑡−1 ∗ 𝐷. 𝑆𝑇𝐴𝐵𝐿𝐸𝑡−1－0.071*(0.029)𝐷∆𝐶𝐹𝑡 ∗ ∆𝐶𝐹t ∗ 𝐴𝐵𝑇𝑀𝑡−1 ∗ 𝐷. 𝑆𝑇𝐴𝐵𝐿𝐸𝑡−1

0.419***(0.000)𝐷∆𝐶𝐹𝑡 ∗ ∆𝐶𝐹t ∗ 𝐷. 𝐽𝐹𝑂𝑅𝐸𝐼𝐺𝑁𝑡−1－0.551(0.168)𝐷∆𝐶𝐹𝑡 ∗ ∆𝐶𝐹t ∗ 𝐶𝐿𝐸𝑉𝑀𝑉𝑡−1 ∗ 𝐷. 𝐽𝐹𝑂𝑅𝐸𝐼𝐺𝑁𝑡−1－0.131***(0.000)𝐷∆𝐶𝐹𝑡 ∗ ∆𝐶𝐹t ∗ 𝐴𝐵𝑇𝑀𝑡−1 ∗ 𝐷. 𝐽𝐹𝑂𝑅𝐸𝐼𝐺𝑁𝑡−1

0.493***(0.000)𝐷∆𝐶𝐹𝑡 ∗ ∆𝐶𝐹t ∗ 𝑆𝐼𝑍𝐸𝑡−1－0.221***(0.000)intercept

0.017(0.342)

F

313.42N

18255

Notes:
𝐴𝐶𝐶𝑡 : accruals in year t deflated by average total assets. ∆𝐶𝐹𝑡 : changes in cash flows from operations deflated byaverage total assets. 𝐷∆𝐶𝐹𝑡 : a dummy variable, taking the value of 1 if ∆𝐶𝐹𝑡 is negative and 0 otherwise. 𝑆𝑇𝐴𝐵𝐿𝐸𝑡−1 :the percentage of shares owned by the largest to the tenth-largest shareholders and other persons or companies
affiliated with the company as defined in Quants Research. 𝐷. 𝑆𝑇𝐴𝐵𝐿𝐸𝑡−1 : a dummy variable takes the value of one
if the proportion of stable shareholders is above the mean and zero otherwise. 𝐽. 𝐹𝑂𝑅𝐸𝐼𝐺𝑁𝑡−1 : the percentage ofshares owned by foreign individuals or institutions in Japan. 𝐷. 𝐽𝐹𝑂𝑅𝐸𝐼𝐺𝑁𝑡−1 : a dummy variable takes the value of
one if the proportion of foreign shareholders is above the mean and zero otherwise. 𝐶𝐿𝐸𝑉𝑀𝑉t−1 : change in total
liabilities deflated by beginning-of-period market capitalization. 𝐴𝐵𝑇𝑀𝑡−1 : total assets / market capitalization + total
assets －common equity, both measured at the end of fiscal year t－1. 𝑆𝐼𝑍𝐸𝑡−1 : the natural logarithm of market
capitalization at the end of fiscal year t－1. ***, **, * indicate significance at the two-tailed 1%, 5%, 10% confidence
level, respectively.

𝑇𝑟. 𝐶𝐿𝐸𝑉𝑀𝑉𝑡−1 ∗ 𝑋𝑡−1 + 𝛼19 𝐷∆𝐶𝐹𝑡 ∗ ∆𝐶𝐹t ∗ 𝑇𝑟. 𝐶𝐿𝐸𝑉𝑀𝑉𝑡−1 ∗ 𝑋𝑡−1 + 𝛼20 𝐵𝑇𝑀𝐷𝑡 ∗ 𝑋𝑡−1 + 𝛼21 𝐷∆𝐶𝐹𝑡 ∗𝐵𝑇𝑀𝐷𝑡 ∗ 𝑋𝑡−1 + 𝛼22 ∆𝐶𝐹t ∗ 𝐵𝑇𝑀𝐷𝑡 ∗ 𝑋𝑡−1 + 𝛼23 𝐷∆𝐶𝐹𝑡 ∗ ∆𝐶𝐹t ∗ 𝐵𝑇𝑀𝐷𝑡 ∗ 𝑋𝑡−1 + 𝛼24 ∆𝑅𝐸𝑉𝑡 + 𝛼25 𝐺𝑃𝑃𝐸𝑡 +𝑦𝑒𝑎𝑟 𝑓𝑖𝑥𝑒𝑑 𝑒𝑓𝑓𝑒𝑐𝑡𝑠 + 𝑖𝑛𝑑𝑢𝑠𝑟𝑡𝑦 𝑓𝑖𝑥𝑒𝑑 𝑒𝑓𝑓𝑒𝑐𝑡𝑠 + 𝜀𝑡
𝑇𝑟. 𝐶𝐿𝐸𝑉𝑀𝑉𝑡−1 is a dummy variable taking the value of one if 𝐶𝐿𝐸𝑉𝑀𝑉𝑡−1 is positive and zero otherwise.
𝐵𝑇𝑀𝐷𝑡 is a dummy variable takes the value of one when 𝐴𝐵𝑇𝑀𝑡−1 is above one, and zero otherwise.

30

To summarize test results in this section, findings in this section, together with test
results in Section 5.2.3 (GLM-SELECT), suggest that the relationship between foreign
shareholdings and accounting conservatism is indirect and weak. Finally, test results
also uphold the importance of regulatory power. Table 7 presents the test results for eachhypothesis in this study.
Table 7 : Summary of Test Results A
H1

upholdH2upholdH3unanswered

H4

rejected

Sign on 𝑆𝑇𝐴𝐵𝐿𝐸𝑡−1 is significantly negative in Models 1 through 3.
Contradicting evidence found in Model 4.
Sign on 𝐶𝐿𝐸𝑉𝑀𝑉𝑡−1 ∗ 𝑆𝑇𝐴𝐵𝐿𝐸𝑡−1 is significantly negative in Models 2,3,
and 4.

No significant evidence found in Models 2,3 and 4.
Sign on ABTMt−1 ∗ 𝑆𝑇𝐴𝐵𝐿𝐸𝑡−1 is significantly positive in Models 2, 3 and4.

Notes:
Models 1 and 2 modify Basu’s [1997] framework through incorporating ownership variables into an earnings-return
regression. Model 3 utilize a model select technique (GLM-SELECT) with T_SCORE or CONSKEW being thedependent variable. Model 4 modifies Ball and Shivakumar’s [2006] framework through incorporating ownershipvariables into an accrual-based model.

6.2 Discussion on Foreign capitals
Research design in this study fails to take the endogeneity concerns into consideration.
Specially, although little evidence is found with regards to the influence of foreign equity
on accounting conservatism in the second essay, it is still possible that foreign investors
incline to choose firms with lower information asymmetric and such firms are thus
expected to be more sensitive to bad news. To validate these arguments in prior studies,
I investigate investment of foreign equity drawing on anecdotal evidence from two
Japanese listed companies. Table 8 exhibits changes in the ten largest shareholders in
TOSHIBA and Olympus in fiscal year 2012 and 2017, respectively. Both companies havebeen reported to engage in inappropriate accounting practices, which have raised
concerns over the credibility of financial reporting in the public. In panel A, it is clearthat foreign investment only accounts for 2.2% of the whole equity in fiscal year 2012 for
TOSHIBA. However, the proportion of foreign equity rose to 19.6% (8.9% + 6.9% + 3.8%)
after its accounting scandal came into light in fiscal year 2017. The case of Olympus issimilar to that of TOSHIBA. In fiscal year 2012, foreign equity accounted for about 4.3%
(2.5% + 1.8%) of the whole equity and has gradually risen to 10.8% (4.9% +4.1% +1.8%)
through fiscal year 2017. The rise in proportion of foreign equity can be viewed as asignal to the market as well as to other stakeholders by showing its commitment to31

corporation governance reformation. Another possible explanation could be that foreign
investors will opt for bargains due to lack of investment opportunity. In other words,
there is a great likelihood that such incidents present an otherwise extremely rare
chance for foreign investors to buy in stocks with great value at a much lower cost.
Although such evidence hinges to a peculiar situation and is inadequate to fully
disentangle the puzzles posed in prior research, it is possible that foreign equity does notnecessarily a priori prone for more conservative firms. Moreover, test results in thisstudy also show that higher foreign equity does not directly link with higher accounting
quality, implying that foreign investors are not capable of influencing managerial
decisions or reinforcing public information production. Future research could explore
effects of foreign investment by tracing the change in equity holdings and variations in
expected length of shareholdings (long-term, mid-term or short-term foreign investors).
As a final note in this section, this study is a preliminary attempt to explore effects ofaccounting standards as well as its association with other influential factors on
accounting conservatism. Although findings in this study provides some important
implications for investors, accounting regulators and standards setters, great gaps
remain between theoretical construction and the application of accounting standards ona practical level. Future work will seek to address this issue through model
sophistication and data mining techniques.

32

Table 8 Panel A : Antidotal Evidence in Case of TOSHIBA (The largest ten shareholders)
2012

2017

The Master Trust Bank of Japan

5.8

GOLDMAN SACHS INTERNATIONAL

8.9

Japan Trustee Services Bank (JTSB)

5.5

JP MORGAN CHASE BANK 380055

6.9

The Dai-ichi Life Insurance Company, Ltd

2.7

CHASE MANHATTAN BANK GTS CLIENTS

3.8

ACCOUNT ESCROW
Nippon Life Insurance Company

2.6

The Dai-ichi Life Insurance Company, Ltd

2.7

SSBT OD05 OMNIBUS ACCOUNT-TREATY

2.2

employee stock ownership committee

2.7

employee stock ownership committee

2.2

Nippon Life Insurance Company

2.6Japan Trustee Services Bank (JTSB) Account

1.9

Japan Trustee Services Bank (JTSB)

2.2

1.5

Japan Trustee Services Bank (JTSB) Account

1.9

CLIENTS

9
Japan Trustee Services Bank (JTSB) Account
4

No.5

NIPPONKOA INSURANCE CO., LTD

1.2

The Master Trust Bank of Japan

1.6

Sumitomo

1.2Japan Trustee Services Bank (JTSB) Account

1.4

Mitsui

Banking

Corporation(SMBC)

No 1

Table 8 Panel B : Antidotal Evidence in Case of Olympus (The largest ten shareholders)
2012

2017

Nippon Life Insurance Company

4.8

The Master Trust Bank of Japan

8.0

The Bank of Tokyo-Mitsubishi UFJ, Ltd.

4.8

Sony, Ltd.

5.0

The Master Trust Bank of Japan

3.7

State Street Corporation 505001

4.9Japan Trustee Sumitomo Mitsui Banking

3.3Japan Trustee Services Bank

4.5

3.1

State Street Corporation 505223

4.1

3.0

Nippon Life Insurance Company

3.9

Morgan Stanley Capital International

2.5

The Bank of Tokyo-Mitsubishi UFJ, Ltd.

3.9

TERUMO CORPORATION

2.0

Japan Trustee Sumitomo Mitsui Banking

3.3

Account
Japan Trustee Services Bank
Sumitomo

Mitsui

Banking

Corporation(SMBC)

Account
State Street Corporation7

1.8

Sumitomo Mitsui Banking Corporation (SMBC)

2.4

Treasure Stock

1.6

State Street Corporation

1.8

7Founded in 1792, State Street Corporation is the second oldest financial institution in the UnitedStates of America.

33

7. Conclusion
This study has sought out to add to the extant literature on how ownership structure isassociated with accounting conservatism in a unique institutional environment. The
institutional features in Japan provides a desirable setting to evaluate the impact ofownership on accounting practice, and to investigate whether this impact differs
systematically with the institutional basics. Prior study has already pointed out that thelevel of accounting conservatism adopted in a firm associates with the relativeequilibrium results from conflicting of interests between different stakeholders (e.g.,
Cullinan et al. [2012]). Findings in this study compliments prior studies and show thatstable shareholdings can weaken shareholders’ incentive to monitor, lead to variation in
management’s accounting decisions and result in lower level of conservatism.
This study also aims to examine whether other factors which are in favor of accounting
conservatism resists or facilitates influence of a unique governance mechanism. For
example, evidence documented in previous studies has provided much insight on theinterrelated relation between debt contracting and conservative reporting. (e.g., Qiang[2007], Ball et al. [2008], Beatty et al. [2008], Nakamura [2009], Nikolaev [2010], Haw
et al. [2014]). In short, debt holders need a lower bound on the annual reporting to detectvalue deterioration and thus prevent exploitation from management and shareholders.
Firms benefit from more conservative accounting to reduce capital cost. However,reporting practices varies across different accounting regimes and thereby could possibly
affect the effectiveness of this mechanism. Table 9 summarizes the main findings
concerning the cross effects of debt contracting. It demonstrates the sign and significancelevel on the main effect of each predictor tested in this study and their interaction terms.
First, effects of debt contract on average fluctuate between stable shareholdings andforeign shareholdings. Overall, evidence found in this study attests to the conjecture thatdebt holders overlook sign for loss recognition when the proportion of stable shareholders
is larger. Nonetheless, monitoring from debt holders strengthens when the proportion offoreign equity rises.
Another explanation for the rising of accounting conservatism is regulator’s demands
for accounting conservatism (Watts [2003], Qiang [2007]). Notwithstanding, one
frequently voiced concern in the context of accounting conservatism is management’s
willingness to recognize losses as per requirements of the accounting standards. In spiteof the fact that management has an asymmetric incentive to recognize gains earlier thanlosses, the flexibilities inherent in the accounting standards could have failed to curb
such opportunistic accounting behavior (e.g., Francis et al. [1996], Riedl [2004]). In thisstudy, I employed the measure of ASSET-BTM proposed in Lawrence et al. [2013] to34

examine the effect of mandated regulation on accounting practice in both crounties. As
is shown in Table 9, Japan has a better enforcement enviorment to improve accounting
quality. In particular, it nulified stable shareholder’s disclosure preference over lessconservative accoutnting. On the other hand, no substancial proof verifies or subverts
hypothses with regards to effects of foreign equity.
Although the core evidence in this study is on average robust, test results may sufferfrom model misspecifications and omitted variables. Variables proxy for ownership
structure also need further screening to account for their genuine effects over accounting
policies. Furthermore, other measures (e.g., 𝐶𝐿𝐸𝑉𝑀𝑉) employed in this study may not
be sophisticated enough to pick up the actual effects as intended. Finally, more work is
required to enhance theoretical establishment.
This study highlights the notion that accounting quality is a function of institutionalsetting in which the firm resides. To my knowledge, this study constitutes the first effort
to examine how differential ownership structure, debt contracting arrangements, andaccounting regulations interplay over accounting conservatism. There are, however,alternative explanations for accounting conservatism (e.g., interest conflicts between
shareholders and management). For example, Iwasaki et al. [2018] indicates that the exante information environment in Japan results in greater demands for accounting
conservatism in firms whose management receive higher earnings-based compensation.
Hence, a more extensive examination of the combined effects of drivers, as well as otherinstitutional features, would provide more profound insights into our understanding ofaccounting conservatism. As data become more widely available, future work willcontinue to focus on identifying and evaluating the effects of institutional differences on
accounting conservatism and other earnings qualities.

35

Table 9 Summary of Test Results B
Basu

AccrualT_SCORECONSKEW

𝐶𝐿𝐸𝑉𝑀𝑉𝑡−1

＋

－

－*

𝐶𝐿𝐸𝑉𝑀𝑉𝑡−1－**

𝐴𝐵𝑇𝑀𝑡−1

+

＋*

＋***

𝐴𝐵𝑇𝑀𝑡−1

𝐷. 𝑆𝑇𝐴𝐵𝐿𝐸𝑡−1

－

－***

＋***

𝑆𝑇𝐴𝐵𝐿𝐸𝑡−1

𝐶𝐿𝐸𝑉𝑀𝑉𝑡−1 ∗ 𝐷. 𝑆𝑇𝐴𝐵𝐿𝐸𝑡−1

－

－***

－*

𝐶𝐿𝐸𝑉𝑀𝑉𝑡−1 ∗ 𝑆𝑇𝐴𝐵𝐿𝐸𝑡−1－***

𝐴𝐵𝑇𝑀𝑡−1 ∗ 𝐷. 𝑆𝑇𝐴𝐵𝐿𝐸𝑡−1

－

＋***

＋***

𝐴𝐵𝑇𝑀𝑡−1 ∗ 𝑆𝑇𝐴𝐵𝐿𝐸𝑡−1

＋***

＋***

𝐷. 𝐽𝐹𝑂𝑅𝐸𝐼𝐺𝑁𝑡−1

－

＋

－

𝐽. 𝐹𝑂𝑅𝐸𝐼𝐺𝑁𝑡−1

𝐶𝐿𝐸𝑉𝑀𝑉𝑡−1 ∗ 𝐷. 𝐽𝐹𝑂𝑅𝐸𝐼𝐺𝑁𝑡−1

－

+*

－***

𝐶𝐿𝐸𝑉𝑀𝑉𝑡−1 ∗ 𝐽. 𝐹𝑂𝑅𝐸𝐼𝐺𝑁𝑡−1

＋***

＋**

𝐴𝐵𝑇𝑀𝑡−1 ∗ 𝐷. 𝐽𝐹𝑂𝑅𝐸𝐼𝐺𝑁𝑡−1

－

+*

＋***

𝐴𝐵𝑇𝑀𝑡−1 ∗ 𝐽. 𝐹𝑂𝑅𝐸𝐼𝐺𝑁𝑡−1

＋***

－***

Notes:𝑆𝑇𝐴𝐵𝐿𝐸𝑡−1 : the percentage of shares owned by the largest to the tenth-largest shareholders and other persons orcompanies affiliated with the company as defined in Quants Research. 𝐷. 𝑆𝑇𝐴𝐵𝐿𝐸𝑡−1 : a dummy variable takes thevalue of one if the proportion of stable shareholders is above the mean and zero otherwise. 𝐽. 𝐹𝑂𝑅𝐸𝐼𝐺𝑁𝑡−1 : thepercentage of shares owned by foreign individuals or institutions in Japan. 𝐷. 𝐽𝐹𝑂𝑅𝐸𝐼𝐺𝑁𝑡−1 : a dummy variable takes
the value of one if the proportion of foreign shareholders is above the mean and zero otherwise. 𝐶𝐿𝐸𝑉𝑀𝑉t−1 : change
in total liabilities deflated by beginning-of-period market capitalization. 𝐴𝐵𝑇𝑀𝑡−1 : total assets / market
capitalization + total assets －common equity, both measured at the end of fiscal year t－1. ***, **, * indicate
significance at the two-tailed 1%, 5%, 10% confidence level, respectively.

36

Appendix 1:
Table A:Variable Definition
Variable

Definition

𝑆𝑇𝐴𝐵𝐿𝐸𝑡−1

the percentage of shares owned by the largest to the tenth-largest shareholders
and other persons or companies affiliated with the company as defined in Quants
Research

𝐷. 𝑆𝑇𝐴𝐵𝐿𝐸𝑡−1

a dummy variable takes the value of one if the proportion of stable shareholders
is above the mean and zero otherwise

𝐽. 𝐹𝑂𝑅𝐸𝐼𝐺𝑁𝑡−1

the percentage of shares owned by foreign individuals or institutions in Japan

𝐷. 𝐽𝐹𝑂𝑅𝐸𝐼𝐺𝑁𝑡−1

a dummy variable takes the value of one if the proportion of foreign shareholders
is above the mean and zero otherwise

𝐴. 𝐽𝐹𝑂𝑅𝐸𝐼𝐺𝑁𝑡−1
𝐸𝑡

the relative proportion of foreign investors in total shareholding
𝐴. 𝐽𝐹𝑂𝑅𝐸𝐼𝐺𝑁𝑡−1 = 𝐽. 𝐹𝑂𝑅𝐸𝐼𝐺𝑁𝑡−1 /(1 − 𝑆𝑇𝐴𝐵𝐿𝐸𝑡−1 )net income in fiscal year t deflated by market capitalization measured at the endof fiscal year t－1.

𝑅𝑡

the buy-and-hold return on common stock for the twelve months ending threemonths after the end of fiscal year t.

𝐷𝑅𝑡a dummy variable, taking a value of 1 if 𝑅𝑡 is negative, and 0 otherwise.

𝐶𝐿𝐸𝑉𝑀𝑉𝑡−1

change in total liabilities deflated by beginning-of-period market capitalization

𝐴𝐵𝑇𝑀𝑡−1

total assets deflated by the sum of market capitalization and total assets minus
common equity

𝑇_𝑆𝐶𝑂𝑅𝐸𝑡a firm-year conservatism measure devised in Khan and Watts [2009]𝐶𝑂𝑁𝑆𝐾𝐸𝑊𝑡

the difference between the skewness of cash flows from operating activities andthe skewness of net income using a three-year rolling window

𝐴𝐶𝐶𝑡

accruals deflated by average total assets∆𝐶𝐹𝑡changes in cash flows from operations deflated by average total assets𝐷∆𝐶𝐹𝑡a dummy variable, taking the value of 1 if ∆𝐶𝐹 is negative and 0 otherwise

𝑃𝑃𝐸𝑡

the proportion of property, plant and equipment assets to total assets

𝑆𝐼𝑍𝐸𝑡

natural logarithm of the company’s market capitalization

𝑊𝐸𝐴𝐾𝑡

a dummy variable takes the value of 1 if 𝐿𝑅𝑂𝐴𝑡 or 𝐿𝑅𝑡 is below 5% and 0
otherwise. 𝐿𝑅𝑂𝐴t is a lag indicator for 𝑅𝑂𝐴, computed as the average value of
𝑅𝑂𝐴𝑡−1 and 𝑅𝑂𝐴𝑡−2 . 𝐿𝑅𝑡 is a lag indicator for 𝑅𝑂𝐴, computed as the averagevalue of 𝑅𝑡−1 and 𝑅𝑡−2 . 𝑅𝑂𝐴𝑡 is measured as income before extraordinary items
deflated by book value of total assets, both measured at the end of fiscal year t. 𝑅𝑡
is the buy-and-hold return on common stock for the twelve months ending threemonths after the end of fiscal year t

37

𝐷𝐸𝐵𝑇𝑡−1

proceeds from the issuance of bonds in year t－1 deflated by market capitalizationof common equity at the end of year t－1

𝐺𝑊𝑡−1

book value of goodwill deflated by total assets, both measured at the end of fiscal
year t－1

𝐼𝑁𝑇𝐴𝑡−1book value of intangible assets deflated by total assets, both measured at the endof fiscal year t－1

𝑅𝐷𝑡−1

expenditure on research and development deflated by total sales, both measured
at the end of fiscal year t－1

𝑙𝑛𝐴𝐺𝐸𝑡−1

the natural logarithm firm age

38

Appendix 2: Correlation matrix for the variables. Spearman correlations in the upper quadrant and Pearson correlations in the lower
quadrant.
Table B: Japan Correlation matrix
𝐸𝑡

𝐷𝑅𝑡

𝑅𝑡−1

𝐴𝐶𝐶𝑡

∆𝐶𝐹𝑡

𝐷∆𝐶𝐹𝑡

𝐴𝐵𝑇𝑀𝑡−1

𝑆𝐼𝑍𝐸𝑡−1

𝐶𝐿𝐸𝑉𝑀𝑉𝑡−1 𝑆𝑇𝐴𝐵𝐿𝐸𝑡−1

𝐽. 𝐹𝑂𝑅𝐸𝐼𝐺𝑁𝑡−1

𝐸𝑡

1.000

－0.1023*0.134*

0.184*

0.081*－0.073*0.088*－0.073*0.067*

0.127*－0.026*𝐷𝑅𝑡－0.052*1.000－0.861*0.034*－0.082*0.072*－0.102*0.034*

0.061*

0.018*

0.017*

𝑅𝑡−1

0.001

－0.108*1.000－0.038*0.097*－0.080*0.135*－0.033*－0.073*－0.039*－0.019*𝐴𝐶𝐶𝑡

0.265*

0.0162*

0.014

1.000

－0.476*0.365*－0.050*0.006

0.081*－0.018*

0.010

∆𝐶𝐹𝑡

0.024*－0.032*0.012－0.290*1.000－0.865*－0.016*－0.0020.044*

0.019*

0.009

𝐷∆𝐶𝐹𝑡

－0.037*0.074*－0.0140.275*－0.348*1.000

0.033*－0.039*－0.034*0.000－0.039*

𝐴𝐵𝑇𝑀𝑡−1

0.010－0.099*0.002－0.057*－0.0020.032*

1.000－0.450*－0.091*0.033*－0.267*

𝑆𝐼𝑍𝐸𝑡−1

0.019*

0.048*－0.015*

0.015

0.000

－0.034*－0.393*1.000

0.097*－0.247*0.737*

𝐶𝐿𝐸𝑉𝑀𝑉𝑡−1

0.014

0.011

－0.0020.024*

0.053*－0.012－0.010

0.010

1.000

0.041*

0.087*𝑆𝑇𝐴𝐵𝐿𝐸𝑡−1

0.042*

0.020*－0.023*－0.0050.006－0.0050.004－0.252*0.015*

1.000－0.219*

𝐽. 𝐹𝑂𝑅𝐸𝐼𝐺𝑁𝑡−1－0.0120.005－0.012

0.010

0.002

－0.039*－0.234*0.669*

0.003－0.1881.000

Notes:
𝐸𝑡 denotes the net income in fiscal year t deflated by market capitalization measured at the end of fiscal year t－1. 𝑅𝑡−1 : the buy-and-hold return on common stock for the twelve
months ending three months after the end of fiscal year t－1. 𝐷𝑅𝑡 : dummy variable, taking a value of 1 if 𝑅𝑡−1 is negative, and 0 otherwise. 𝐴𝐶𝐶𝑡 : accruals in year t deflated byaverage total assets. ∆𝐶𝐹𝑡 : changes in cash flows from operations deflated by average total assets. 𝐷∆𝐶𝐹𝑡 : a dummy variable, taking the value of 1 if ∆𝐶𝐹𝑡 is negative and 0 otherwise.
𝐴𝐵𝑇𝑀𝑡−1 : total assets / market capitalization + total assets －common equity, both measured at the end of fiscal year t－1. 𝐴𝐵𝑇𝑀𝑡−1 : total assets market capitalization + total assets－common equity, both measured at the end of fiscal year t－1. 𝑆𝐼𝑍𝐸𝑡−1 : the natural logarithm of market capitalization at the end of fiscal year t－1. 𝑆𝐼𝑍𝐸𝑡−1 : the natural logarithm of market
capitalization at the end of fiscal year t－1. 𝐶𝐿𝐸𝑉𝑀𝑉t−1 is measured as the change in total liabilities deflated by beginning-of-period market capitalization. 𝑆𝑇𝐴𝐵𝐿𝐸𝑡−1 : thepercentage of shares owned by the largest to the tenth-largest shareholders and other persons or companies affiliated with the company as defined in Quants Research.
𝐽. 𝐹𝑂𝑅𝐸𝐼𝐺𝑁𝑡−1 : the percentage of shares owned by foreign individuals or institutions in Japan.

39

Appendix 3: Regression Results for T_SCORE
Khan and Watts [2009] incorporated three firm-specific characteristics into the Basumodel to estimate an annual across-sectional Basu coefficient. These are firm size (𝑆𝐼𝑍𝐸),
marker-to-book ratio (𝑀𝑇𝐵), and market value leverage (𝐿𝐸𝑉𝑀𝑉). 𝐺_𝑆𝐶𝑂𝑅𝐸 in Eq. 3
denotes the timeliness of good news being reflected on income statements, and 𝐶_𝑆𝐶𝑂𝑅𝐸
in Eq. 4 denotes the incremental timeliness of bad news being reflected on income
statements. However, Eq. 3 and Eq. 4 are not regression models. Instead, Khan andWatts [2009] substituted them into the Basu model to estimate parameters 𝜇𝑖 and 𝛾𝑖(i=1~4). Then, 𝜇𝑖 and 𝛾𝑖 (i=1~4) were in turn substituted into Eq. 3 and Eq. 4 as
empirical estimators to compute annual 𝐺_𝑆𝐶𝑂𝑅𝐸 and 𝐶_𝑆𝐶𝑂𝑅𝐸 for each firm/year
sample. 𝑇_𝑆𝐶𝑂𝑅𝐸 is thus the sum of 𝐺_𝑆𝐶𝑂𝑅𝐸 and 𝐶_𝑆𝐶𝑂𝑅𝐸 , which measures thedegree of conditional conservatism.
The model applied in this study is outlined below, where 𝑆𝐼𝑍𝐸𝑡 represents the naturallog of market capitalization; 𝑀𝑇𝐵𝑡 represents the ratio of market capitalization to thebook value of common equity at the end of the year t. 𝐿𝐸𝑉𝑀𝑉𝑡 represents leverage whichis calculated as book value of total liabilities deflated by the market capitalization. In
this study, 𝐸𝑡 , the dependent variable in Eq.5, denotes the net income in fiscal year t
deflated by market capitalization measured at the end of fiscal year t－1. 𝑅𝑡 is the buyand-hold return on common stock for the twelve months ending three months after theend of fiscal year t. As with Basu [1997], 𝐷𝑅𝑡 is a dummy variable that equals 1 if 𝑅𝑡 is
negative and is 0 otherwise. Table 9 reports the regression results. T_SCORE used in thisstudy is measured on the basis of Eq. 3 and 4.
𝐺_𝑆𝐶𝑂𝑅𝐸＝𝛽3 = 𝜇̂1 + 𝜇̂𝑆𝐼𝑍𝐸̂𝑀𝑇𝐵̂𝐿𝐸𝑉𝑀𝑉2𝑖,𝑡 + 𝜇3
𝑖,𝑡 + 𝜇
4
𝑖,𝑡

Eq.3

𝐶_𝑆𝐶𝑂𝑅𝐸 = 𝛽4 = 𝛾̂1 + ̂𝑆𝐼𝑍𝐸
𝛾2𝛾3𝛾4𝑖,𝑡 + ̂𝑀𝑇𝐵𝑖,𝑡 + ̂𝐿𝐸𝑉𝑀𝑉
𝑖,𝑡

Eq.4

𝐸𝑡 = 𝛽1 + 𝛽2 𝐷𝑅𝑖,𝑡 + 𝑅𝑖,𝑡 (𝜇1 + 𝜇2 𝑆𝐼𝑍𝐸𝑖,𝑡 + 𝜇3 𝑀𝑇𝐵𝑖,𝑡 + 𝜇4 𝐿𝐸𝑉𝑀𝑉𝑖,𝑡 ) + 𝐷𝑅𝑖,𝑡 𝑅𝑖,𝑡 ( 𝛾1 + 𝛾2 𝑆𝐼𝑍𝐸𝑖,𝑡 + 𝛾3 𝑀𝑇𝐵𝑖,𝑡 +𝛾4 𝐿𝐸𝑉𝑀𝑉𝑖,𝑡 ) + ( 𝛿1 𝑆𝐼𝑍𝐸𝑖,𝑡 + 𝛿2 𝑀𝑇𝐵𝑖,𝑡 + 𝛿3 𝐿𝐸𝑉𝑀𝑉𝑖,𝑡 + 𝛿4 𝐷𝑅𝑖,𝑡 𝑆𝐼𝑍𝐸𝑖,𝑡 + 𝛿5 𝐷𝑅𝑖,𝑡 𝑀𝑇𝐵𝑖,𝑡 +Eq.5

𝛿6 𝐷𝑅𝑖,𝑡 𝐿𝐸𝑉𝑀𝑉𝑖,𝑡 ) + 𝜀𝑖

40Table C : Regression Results for T_SCORE
Japan
𝛽2(𝐷𝑅)

0.036(0.075)𝜇1(𝑅)0.028*(0.039)𝜇2 (𝑅 ∗ 𝑆𝐼𝑍𝐸)－0.003*(0.023)𝜇3 (𝑅 ∗ 𝑀𝑇𝐵)

－0.0003(0.546)

𝜇4 (𝑅 ∗ 𝐿𝐸𝑉𝑀𝑉)－0.009***(0.000)𝛾1 (𝐷𝑅 ∗ 𝑅)

0.142*(0.025)𝛾2 (𝐷𝑅 ∗ 𝑅 ∗ 𝑆𝐼𝑍𝐸)－0.006(0.286)𝛾3 (𝐷𝑅 ∗ 𝑅 ∗ 𝑀𝑇𝐵)

－0.0007(0.230)𝛾4 (𝐷𝑅 ∗ 𝑅 ∗ 𝐿𝐸𝑉𝑀𝑉)

0.005(0.055)0.003***

𝛿1 (𝑆𝐼𝑍𝐸)(0.000)0.0004

𝛿2 (𝑀𝑇𝐵)(0.310)－0.006***

𝛿3 (𝐿𝐸𝑉𝑀𝑉)(0.000)－0.001

𝛿4 (𝐷𝑅 ∗ 𝑆𝐼𝑍𝐸)(0.466)
𝛿5 (𝐷𝑅 ∗ 𝑀𝑇𝐵)

－0.001(0.117)－0.001

𝛿6 (𝐷𝑅 ∗ 𝐿𝐸𝑉𝑀𝑉)(0.322)
0.053***

intercept(0.000)
24.37

𝐹

41

18255𝑁Note:
𝑁 denotes the number of observations in each ASSET-BTM group. 𝐸𝑡 denotes the net income in fiscal year t,
deflated by market capitalization at the end of fiscal year t－1. 𝑅𝑡 is the buy-and-hold return on common stock forthe twelve months ending three months after the end of fiscal year t. 𝐷𝑅𝑡 is a dummy variable that equals one if
𝑅 is negative and is zero otherwise. 𝑆𝐼𝑍𝐸𝑡 represents the natural log of market capitalization. 𝑀𝑇𝐵𝑡 represents
market capitalization to book value of common equity at the end of fiscal year t. 𝐿𝐸𝑉𝑀𝑉𝑖,𝑡 represents leverage, whichis calculated as book value of total liabilities deflated by market capitalization at the end of fiscal year t. ***, **, *indicate significance at the two-tailed 1%, 5%, 10% confidence level, respectively.

42

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