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The Link between Earnings Conservatism and the Price†to†Book Ratio

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  • JINHAN PAE
  • DANIEL B. THORNTON
  • MICHAEL WELKER

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.

Suggested Citation

  • Jinhan Pae & Daniel B. Thornton & Michael Welker, 2005. "The Link between Earnings Conservatism and the Price†to†Book Ratio," Contemporary Accounting Research, John Wiley & Sons, vol. 22(3), pages 693-717, September.
    • Handle: RePEc:wly:coacre:v:22:y:2005:i:3:p:693-717
    DOI: 10.1506/9FDN-N6ED-LJE9-A1HL
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    Cited by:

    1. Hyung Jong Na & Kun Chang Lee & Seung Uk Choi & Seong Tae Kim, 2020. "Exploring CEO Messages in Sustainability Management Reports: Applying Sentiment Mining and Sustainability Balanced Scorecard Methods," Sustainability, MDPI, vol. 12(2), pages 1-21, January.
    2. Khalifa, Mariem & Trabelsi, Samir & Matoussi, Hamadi, 2022. "Leverage, R&D expenditures, and accounting conservatism: Evidence from technology firms," The Quarterly Review of Economics and Finance, Elsevier, vol. 84(C), pages 285-304.
    3. Sihem Hmani, 2019. "Unequal Impact of Conditional Conservatism on Components Accruals: Evidence from French Capital Market," Accounting and Finance Research, Sciedu Press, vol. 8(2), pages 245-245, May.
    4. Haider, Imran & Singh, Harjinder & Sultana, Nigar, 2021. "Managerial ability and accounting conservatism," Journal of Contemporary Accounting and Economics, Elsevier, vol. 17(1).
    5. Akram Khalilov & Beatriz Garcia Osma, 2020. "Accounting conservatism and the profitability of corporate insiders," Journal of Business Finance & Accounting, Wiley Blackwell, vol. 47(3-4), pages 333-364, March.
    6. Ray Ball & Lakshmanan Shivakumar, 2006. "The Role of Accruals in Asymmetrically Timely Gain and Loss Recognition," Journal of Accounting Research, Wiley Blackwell, vol. 44(2), pages 207-242, May.
    7. Tri Tri Nguyen & Chau Minh Duong & Nguyet Thi Minh Nguyen & Hung Quang Bui, 2020. "Accounting conservatism and banking expertise on board of directors," Review of Quantitative Finance and Accounting, Springer, vol. 55(2), pages 501-539, August.
    8. Daniel B. Thornton, 2015. "Different Conceptual Accounting Frameworks for Public and Private Enterprises: Commentary on Canada's IFRS Transition and Suggestions for International Empirical Work," Accounting Perspectives, John Wiley & Sons, vol. 14(3), pages 168-189, September.
    9. Hiren Patel, 2021. "Target Price Achievement and Target Price Accuracy Models: An Analysis of Advisory Firms’ Recommendation for the Indian Banking Stocks," Global Business Review, International Management Institute, vol. 22(2), pages 459-473, April.

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