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The Link between Earnings Conservatism and the Price‐to‐Book Ratio *

The Link between Earnings Conservatism and the Price‐to‐Book Ratio * We hypothesize and find that (1) earnings conservatism, the tendency of firms to recognize bad news in earnings on a more timely basis than good news, is substantially greater in portfolios of firms with lower price‐to‐book ratios than in portfolios of firms with higher price‐to‐book ratios; and (2) the negative association between earnings conservatism and the price‐to‐book ratio stems primarily from the accrual component of earnings, not the operating cash flow component of earnings. Our results suggest that studies using earnings‐returns associations to investigate cross‐sectional or time‐series differences in earnings conservatism risk drawing erroneous inferences unless the research designs control for cross‐sectional or time‐series variation in price‐to‐book ratios. http://www.deepdyve.com/assets/images/DeepDyve-Logo-lg.png Contemporary Accounting Research Wiley

The Link between Earnings Conservatism and the Price‐to‐Book Ratio *

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References (15)

Publisher
Wiley
Copyright
2005 Canadian Academic Accounting Association
ISSN
0823-9150
eISSN
1911-3846
DOI
10.1506/9FDN-N6ED-LJE9-A1HL
Publisher site
See Article on Publisher Site

Abstract

We hypothesize and find that (1) earnings conservatism, the tendency of firms to recognize bad news in earnings on a more timely basis than good news, is substantially greater in portfolios of firms with lower price‐to‐book ratios than in portfolios of firms with higher price‐to‐book ratios; and (2) the negative association between earnings conservatism and the price‐to‐book ratio stems primarily from the accrual component of earnings, not the operating cash flow component of earnings. Our results suggest that studies using earnings‐returns associations to investigate cross‐sectional or time‐series differences in earnings conservatism risk drawing erroneous inferences unless the research designs control for cross‐sectional or time‐series variation in price‐to‐book ratios.

Journal

Contemporary Accounting ResearchWiley

Published: Sep 1, 2005

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