archives@tulane.edu / 1 / Ruizhong Zhang

Psychological biases in the form of sentiment can affect various economic decisions including accounting choices. Broadly defined, the term sentiment refers to unjustified beliefs about the future cash flow prospects of the firm (Baker and Wurgler 2006). Asymmetric timely loss recognition (ATLR) is particularly prone to managerial sentiment because the decision to recognize economic gains and losses is based, in part, on managers’ beliefs about the likelihood of future economic events affecting the firms. In this study, I examine the effect of psychological biases about future performance on current accounting choices via the effect of market-level managerial sentiment on ATLR. I find that ATLR decreases with managerial sentiment and that periods of high managerial sentiment are associated with lower concurrent write-offs but higher subsequent write-offs. This study enhances the implications of sentiment on firms’ accounting choices by identifying a time-varying macroeconomic determinant of ATLR that is based on psychological biases about future performance.

This paper uses the collapse of the junk bond market in the early 1990s as a natural experiment to examine the effect of asymmetric timely loss recognition (ATLR) on speculative-grade (SPG) firms' access to private debt markets and underinvestment. For a sample of 450 firm-years over the period 1988-1991, I find that SPG firms that recognize economic losses in a timelier fashion experience a smaller reduction in debt financing and investment from the pre- to post-collapse period relative to SPG firms that recognize economic losses in a less timely fashion. I also document that the effect of ATLR on debt financing and investment is more pronounced for SPG firms that lack collateral and are not followed by sell-side equity analysts. These findings support the notion that ATLR improves a firm's ability to access private debt markets, thereby attenuating underinvestment. They also suggest that both collateral and sell-side equity analysts serve as substitutes for ATLR to facilitate SPG firms' access to private debt markets. Further analyses reveal that ATLR increases for SPG firms from the pre- to post-collapse period and this increase is more pronounced for SPG firms with net issuance of debt. This evidence suggests that firms adjust ATLR to obtain debt financing in response to private lenders' demand for it.