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The Link between Earnings Conservatism and the Price‐to‐Book Ratio *
Author(s) -
PAE JINHAN,
THORNTON DANIEL B.,
WELKER MICHAEL
Publication year - 2005
Publication title -
contemporary accounting research
Language(s) - English
Resource type - Journals
SCImago Journal Rank - 2.769
H-Index - 99
eISSN - 1911-3846
pISSN - 0823-9150
DOI - 10.1506/9fdn-n6ed-lje9-a1hl
Subject(s) - earnings , conservatism , accrual , cash flow , economics , earnings response coefficient , price–earnings ratio , econometrics , monetary economics , financial economics , accounting , earnings per share , political science , politics , law
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.