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Valuation: Accounting for Risk and the Expected Return

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  • Stephen Penman

Abstract

type="main"> Under accounting principles, the recognition of earnings is path-dependent and the path depends on risk and its resolution: under the so-called realization principle, earnings are not booked until uncertainty is resolved. In asset pricing terms, the principle means that earnings cannot be recognized until the firm can book a low-beta asset such as cash or a near-cash discounted receivable. If the risk to which this accounting responds is priced risk, the accounting indicates the expected return. This paper connects accounting under this principle to risk and return, summarizes the supporting empirical evidence, and examines the implications for research on the implied cost of capital, cash-flow betas, asset pricing models that imbed accounting numbers, and papers that assume an autoregressive model for the earnings path to infer the expected return. The accounting that captures risk and its resolution also has implications for the unsolved issue of specifying the appropriate accounting for accounting-based valuation models and, indeed, for financial accounting standards.

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  • Stephen Penman, 2016. "Valuation: Accounting for Risk and the Expected Return," Abacus, Accounting Foundation, University of Sydney, vol. 52(1), pages 106-130, March.
    • Handle: RePEc:bla:abacus:v:52:y:2016:i:1:p:106-130
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    File URL: http://hdl.handle.net/10.1111/abac.12067
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    2. Mabel D Costa & Ahsan Habib, 2023. "Cost stickiness and firm value," Journal of Management Control: Zeitschrift für Planung und Unternehmenssteuerung, Springer, vol. 34(2), pages 235-273, June.
    3. Stephen Penman, 2016. "Valuation: The State of the Art," Schmalenbach Business Review, Springer;Schmalenbach-Gesellschaft, vol. 17(1), pages 3-23, April.
    4. Shawn Ho & Baljit K. Sidhu & Fan Yang, 2023. "The response of Australian firms to AASB 138 disallowing the recognition of internally generated identifiable intangibles," Accounting and Finance, Accounting and Finance Association of Australia and New Zealand, vol. 63(3), pages 3609-3641, September.
    5. Matthew R. Lyle, 2016. "Valuation: Accounting for Risk and the Expected Return. Discussion of Penman," Abacus, Accounting Foundation, University of Sydney, vol. 52(1), pages 131-139, March.
    6. David Johnstone, 2016. "Advances in Equity Valuation: Research on Accounting Valuation," Abacus, Accounting Foundation, University of Sydney, vol. 52(1), pages 1-4, March.
    7. Pengguo Wang, 2018. "Future Realized Return, Firm‐specific Risk and the Implied Expected Return," Abacus, Accounting Foundation, University of Sydney, vol. 54(1), pages 105-132, March.
    8. Oveis Madadian & Walter Aerts & Tom Van Caneghem, 2018. "Social comparison of cost behaviour and financial analysts," Accounting and Business Research, Taylor & Francis Journals, vol. 48(7), pages 805-839, November.
    9. Demetris Christodoulou & Colin Clubb & Stuart Mcleay, 2016. "A Structural Accounting Framework for Estimating the Expected Rate of Return on Equity," Abacus, Accounting Foundation, University of Sydney, vol. 52(1), pages 176-210, March.
    10. Correia, Maria & Kang, Johnny & Richardson, Scott, 2018. "Asset volatility," LSE Research Online Documents on Economics 84405, London School of Economics and Political Science, LSE Library.
    11. Carien van Mourik & Yuko Katsuo Asami, 2018. "Articulation, Profit or Loss and OCI in the IASB Conceptual Framework: Different Shades of Clean (or Dirty) Surplus," Accounting in Europe, Taylor & Francis Journals, vol. 15(2), pages 167-192, May.
    12. Atif Ellahie, 2021. "Earnings beta," Review of Accounting Studies, Springer, vol. 26(1), pages 81-122, March.
    13. Stephen Penman & Julie Zhu & Haofei Wang, 2023. "The implied cost of capital: accounting for growth," Review of Quantitative Finance and Accounting, Springer, vol. 61(3), pages 1029-1056, October.
    14. Guilherme Belloque & Martina K Linnenluecke & Mauricio Marrone & Abhay K Singh & Rui Xue, 2021. "55 years of Abacus: Evolution of Research Streams and Future Research Directions," Abacus, Accounting Foundation, University of Sydney, vol. 57(3), pages 593-618, September.
    15. Maria Correia & Johnny Kang & Scott Richardson, 2018. "Asset volatility," Review of Accounting Studies, Springer, vol. 23(1), pages 37-94, March.
    16. Stewart Jones & Nurul Alam, 2019. "A machine learning analysis of citation impact among selected Pacific Basin journals," Accounting and Finance, Accounting and Finance Association of Australia and New Zealand, vol. 59(4), pages 2509-2552, December.
    17. Monahan, Steven J., 2018. "Financial Statement Analysis and Earnings Forecasting," Foundations and Trends(R) in Accounting, now publishers, vol. 12(2), pages 105-215, July.

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