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The pricing of conservative accounting and the measurement of conservatism at the firm-year level

Author

Listed:
  • Jeffrey L. Callen

    (University of Toronto)

  • Dan Segal

    (University of Toronto
    Interdisciplinary Center (IDC) Herzliya)

  • Ole-Kristian Hope

    (University of Toronto)

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.

Suggested Citation

  • Jeffrey L. Callen & Dan Segal & Ole-Kristian Hope, 2010. "The pricing of conservative accounting and the measurement of conservatism at the firm-year level," Review of Accounting Studies, Springer, vol. 15(1), pages 145-178, March.
    • Handle: RePEc:spr:reaccs:v:15:y:2010:i:1:d:10.1007_s11142-009-9087-6
    DOI: 10.1007/s11142-009-9087-6
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    References listed on IDEAS

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    Cited by:

    1. Juan Manuel García Lara & Beatriz García Osma & Fernando Penalva, 2011. "Conditional conservatism and cost of capital," Review of Accounting Studies, Springer, vol. 16(2), pages 247-271, June.
    2. Frank Heflin & Charles Hsu & Qinglu Jin, 2015. "Accounting conservatism and Street earnings," Review of Accounting Studies, Springer, vol. 20(2), pages 674-709, June.
    3. Sudarshan Jayaraman & Lakshmanan Shivakumar, 2013. "Agency-based demand for conservatism: evidence from state adoption of antitakeover laws," Review of Accounting Studies, Springer, vol. 18(1), pages 95-134, March.

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    JEL classification:

    • M41 - Business Administration and Business Economics; Marketing; Accounting; Personnel Economics - - Accounting - - - Accounting
    • G14 - Financial Economics - - General Financial Markets - - - Information and Market Efficiency; Event Studies; Insider Trading

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