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Profitability news or valuation news? A diagnostic analysis on the different news components in conditional conservatism

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  • Shengmin Hung
  • Zheng Qiao

Abstract

The sign of stock return has been widely used to proxy for news in the conditional conservatism model. Under discount cash flow model, firm value changes are caused by either cash flow news or discount rate news. Simply using the sign of stock returns to define good (bad) news can be problematic. Following the classic return decomposition method, this paper decomposes return news into cash flow news and discount rate news. We find that cash flow news component demonstrates consistent results with previous findings. However, with respect to discount rate news, positive return news turns out to be recognized more quickly in earnings. The conventional timeliness asymmetry even disappears in the highest quintile of discount rate news shock magnitude. In additional tests, we also document weakened timeliness asymmetry conditional on a battery of proxy variables for discount rate news. Our findings suggest that we should use stock return sign with caution in conditional conservatism tests, especially when discount rate news shock is large.

Suggested Citation

  • Shengmin Hung & Zheng Qiao, 2018. "Profitability news or valuation news? A diagnostic analysis on the different news components in conditional conservatism," Asia-Pacific Journal of Accounting & Economics, Taylor & Francis Journals, vol. 25(3-4), pages 496-513, May.
    • Handle: RePEc:taf:raaexx:v:25:y:2018:i:3-4:p:496-513
    DOI: 10.1080/16081625.2017.1314189
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