Accounting Conservatism, Debt Capacity, and Corporate Real Estate Holdings: Theory and Empirical Analysis(1/2)

Project Details


This study investigates how accounting conservatism affects corporate real estate (CRE) holdings.Although ample extant empirical studies indicate that accounting conservatism may either encourage ordeter physical investments, none has attempt to link accounting conservatism with CRE holdings whichaccounts for the largest capital investment of many firms. In this research proposal I argue thataccounting conservatism may affect CRE holdings through two channels. One is the “collateral”channel as accounting conservatism enhances a firm’s ability to borrow, and thus increases its capacityfor CRE holdings; while by contrast creditors tend to require less CRE collaterals from a moreconservative firm. As a result no definite effect can be determined for this channel. As for the second“direct” channel, stemming from the focus of most literature which stress on how accountingconservatism affects the physical investments of a firm, would not help clarify the relation as they havenot yielded an unambiguous conclusion. Therefore, in this proposal I plan to first establish a rigorousmodel to link accounting conservatism with CRE holdings of a firm so as to differentiate the impactsfrom different channels.In the first year of this proposal, I plan to extend the two-agents and three-dates model developedby Li (CAR, 2013) by incorporating the determination of corporate debt capacity and also considerimportant real estate market features. The main improvements in my basic model are: (1) By using thebackward-induction concept I derive the optimal debt amount which ensures the creditor in the modelreceives a fair rate of return for her loan; (2) I assume the creditor requires CRE as collaterals for her risky loan, which may appreciate/depreciate in the future; And (3) the entrepreneur can lease therequired extra space in case the investment turns out to be better than her original expectation; In otherwords, CRE holdings and leasing are substituting investments. In an advanced model I will attempt onrelaxing the above third assumption by incorporating Ambrose et al. (forthcoming in RoF)’s modelwhich finds that conditions under which a company’s real estate holdings and leases are compliments.In my model the entrepreneur observes private information regarding the nature of an investmentproject, i.e., good or bad, and then sends an accounting signal to the creditor. It is assumed that theentrepreneur tends to “over-state” the nature of the project to some extent. This tendency relates to howconservative the entrepreneur is, i.e., if she does not over-state the profits of a project much, it impliesthat she applies for higher degree of accounting conservatism. Bearing this definition in mind, thepreliminary results of my basic model indicate that more conservative firms tend to hold more (less)CRE when the real estate appreciation is high (low) but leasing expense are relatively low (high). Inpractice, as the value of real estate and leasing expenses tend to move in the same direction, I plan toempirically answer the above question as the focus of my second year proposal.In the second year I plan to employ the panel data of the U. S. firms listed on the NYSE, AMEX,and NASDAQ exchanges during the period from 1982 to 2014. Firm characteristics includingcompany’s CRE holdings, capital leases ratio, and degree of accounting conservatism will be computedfrom Compustat and CRISP database, while the trend and volatility in real estate market will be drawnfrom public websites such as of National Council of Real Estate Investment Fiduciaries (NCREIF) etc.I plan to estimate a pair of simultaneous equations in which the reduced forms for the determinants ofcorporate debt and CRE holdings will be specified, respectively. Statistical methods such as two-stageleast squares and the generalized method of moments (GMM) will be used for estimating thedeterminants of companies’ financial leverage and their CRE holdings with the s
Effective start/end date1/08/1731/07/18

UN Sustainable Development Goals

In 2015, UN member states agreed to 17 global Sustainable Development Goals (SDGs) to end poverty, protect the planet and ensure prosperity for all. This project contributes towards the following SDG(s):

  • SDG 11 - Sustainable Cities and Communities
  • SDG 12 - Responsible Consumption and Production
  • SDG 17 - Partnerships for the Goals


  • Accounting conservatism
  • Corporate real estate holdings
  • Capital structure
  • Analyticalmodels


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