The East Asian countries Hong Kong, Malaysia, Singapore and Thailand provide rare insight into the interaction between accounting standards and the incentives of managers and auditors. Their standards derive from common law sources (UK, US, and IAS) that are widely viewed as higher quality than code law standards. However, their preparers’ incentives imply low quality. We show their financial reporting quality is not higher than under code law, with quality operationalized as timely recognition of economic income (particularly losses). It is misleading to classify countries by standards, ignoring incentives, as is common in international accounting texts, transparency indexes, and IAS advocacy.

Income variation, Balance sheet, Common size statements method, Financial analysts

ABSTRACT A substantial literature investigates conditional conservatism, defined as asymmetric accounting recognition of economic shocks (“news”), and how it depends on various market, political, and institutional variables. Studies typically assume the Basu [1997] asymmetric timeliness coefficient (the incremental slope on negative returns in a piecewise‐linear regression of accounting income on stock returns) is a valid conditional conservatism measure. We analyze the measure's validity, in the context of a model with accounting income incorporating different types of information with different lags, and with noise. We demonstrate that the asymmetric timeliness coefficient varies with firm characteristics affecting their information environments, such as the length of the firm's operating and investment cycles, and its degree of diversification. We particularly examine one characteristic, the extent to which “unbooked” information (such as revised expectations about rents and growth options) is independent of other information, and discuss the conditions under which a proxy for this characteristic is the market‐to‐book ratio. We also conclude that much criticism of the Basu regression misconstrues researchers’ objectives.