The benefits of unconditional conservatism for stock valuations during the COVID-19 crisis

Abstract

Purpose – We examine whether unconditional conservatism supported stock valuations during the COVID-19 crisis. Building on evidence that this form of conservatism improves downside-risk assessment and mitigates bankruptcy and litigation concerns, we hypothesize that its benefits were amplified during this period of heightened uncertainty, sustaining valuations and reducing investor uncertainty. Design/methodology/approach – We analyze stock price patterns of US-listed firms around the onset of COVID-19. Following prior literature, we employ a composite measure based on three widely used proxies to measure each firm’s level of unconditional conservatism in the preceding three fiscal years (2017–2019). Findings – Consistent with our hypothesis, higher conservatism resulted in superior abnormal stock returns during the crisis. These benefits were especially pronounced in industries more exposed to COVID-19 and among firms with greater reliance on international sales, which made them more susceptible to global disruptions. In contrast, the advantages of conservatism were less evident in firms with stronger corporate governance, greater financial stability, more transparent reporting, and steadier operating performance. We also find that conservatism resulted in lower volatility and narrower spreads during the crisis and was linked to fewer negative special items in 2020, suggesting reduced vulnerability to write-down losses stemming from the pandemic. Originality/value – Our findings suggest that unconditional conservatism, often seen as detrimental to valuation, is beneficial amid significant market uncertainty. We contribute to the long-standing debate on the desirability of conservatism in financial reporting, underscoring the critical role that accounting practices can play for investors and the broader economy.