The pricing of conservative accounting
and the measurement of conservatism
at the ﬁrm-year level
Jeffrey L. Callen Æ Dan Segal Æ Ole-Kristian Hope
Published online: 14 February 2009
Ó Springer Science+Business Media, LLC 2009
Abstract This paper analyzes the relation between equity prices and conditional
conservatism and introduces a new measure of conservatism at the ﬁrm-year level.
We show that the asymmetric properties of conservative accounting, the existence
of non-accounting sources of information, and the properties of GAAP related to
special items combine to generate a nonlinear relation between unexpected equity
returns and earnings news (the shock to expected current and future earnings).
Based on this model, we construct a conservatism ratio (CR) deﬁned as the ratio of
the current earnings shock to earnings news. CR measures the proportion of the total
shock to expected current and future earnings recognized in current year earnings.
Ranking ﬁrms according to CR, we show empirically that higher CR ﬁrms have
more leverage, increased volatility of returns, more incidence of losses, more
negative accruals, and increased volatility of earnings and accruals, consistent with
the literature on conservative accounting.
Keywords Conservatism special items Á Linearity Á Return decomposition Á
JEL Classiﬁcation M41 Á G14
J. L. Callen Á D. Segal (&) Á O.-K. Hope
Rotman School of Management, University of Toronto, 105 St. George St,
Toronto, ON, Canada M5S 3E6
e-mail: firstname.lastname@example.org; email@example.com
J. L. Callen
Arison School of Business, Interdisciplinary Center (IDC) Herzliya,
P.O. Box 167, Herzliya 46150, Israel
Rev Account Stud (2010) 15:145–178