An information-based model for the differential treatment of gains and losses

Review of Accounting Studies · 2018 · Volume 23 · Issue 2

Abstract

This study defines reporting conservatism as a higher verification standard for probable gains compared to losses and builds a model that endogenously generates optimal behavior resembling an asymmetric preference for gains versus losses. Our model considers the setting where one party produces a resource and another tries to expropriate it. The key factor determining the extent of the gain-loss asymmetry is the level of information asymmetry or trust between the two parties. The information asymmetry-based results of our model provide a simpler explanation for the vast empirical literature on conservatism, where the bulk of the economic relationships among the parties appear to be information-based with little direct relation to explicit debt contracts, a factor that has been the focus of theoretical arguments. We also suggest new empirical analyzes.

Keywords

Conservatism, Information asymmetry, Evolution, Risk preferences

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