Accounting Conservatism, the Quality of Earnings, and Stock Returns
Stephen H. Penman
Columbia University - Department of Accounting
Xiao-Jun Zhang
University of California, Berkeley; China Academy of Financial Research (CAFR)
December 1999
Abstract:
Quality of earnings questions arise when firms that practice conservative accounting change the level of their investment in net operating assets: increases in net operating assets create "hidden reserves," depressing earnings, and decreases in investment release hidden reserves into earnings. This paper develops diagnostics that capture this joint effect of investment and conservative accounting and finds that the diagnostics forecast differences in future return on net operating assets from the current return on net operating assets. Moreover, the diagnostics forecast stock returns, indicating that the stock market does not appreciate how conservatism and investment combine to raise quality questions about reported earnings.
Number of Pages in PDF File: 39
JEL Classification: M41, G12, G14
working papers series
Suggested Citation
Penman, Stephen H. and Zhang, Xiao-Jun, Accounting Conservatism, the Quality of Earnings, and Stock Returns (December 1999). Available at SSRN: http://ssrn.com/abstract=201048 or http://dx.doi.org/10.2139/ssrn.201048
