We investigate whether accounting conservatism can be explained as a rational response to ambiguity. Decision analysis shows that decision rules that work well under ambiguity put greater weight on negative than on positive outcomes, i.e., exhibit caution. Accounting conservatism increases the timeliness of bad news that is more relevant under cautious decision rules and thereby helps corporate managers and investors implement them. We, therefore, hypothesize that firms facing greater ambiguity report more conservatively. We adopt two different measures to proxy for the firm-specific level of ambiguity. First, we identify firms pursuing the “prospector” versus “defender” business strategies. Compared with defenders, who focus on utilizing existing resources, prospectors actively create their future by seeking new business opportunities and thus face greater ambiguity. Second, we conduct an additional set of tests based on environmental scanning, which reduces ambiguity. Both sets of results suggest that firms facing greater ambiguity report more conservatively.

This study examines the effect of bank loan monitoring on public bond contract design. We find that bond yield spreads are lower and that bond issuance amounts are larger when a borrower has recently obtained a private loan, consistent with bond issuers benefiting from the screening and ongoing monitoring of banks. We find that these bonds include more covenants than bonds issued without the cross-monitoring of banks, consistent with bondholders wanting to protect themselves from private lenders. This effect is larger for firms with high information asymmetry and larger potential conflicts between different lender types. Our results are robust to a battery of sensitivity tests. Overall, our empirical results suggest that borrowers that precede their public bond issuances with private loan agreements receive more favorable bond terms. Meanwhile, these benefits are associated with the cost of increased monitoring by public bonds.