Valuation and Conservatism
36 Pages Posted: 6 May 2010 Last revised: 7 Jun 2010
Date Written: January 2010
Residual income models provide an important theoretical link between equity valuation and financial statement variables. While various researchers have developed models of how accounting policy impacts on the structure of these models, empirical support for these models is at best weak and frequently contradictory. In this paper, we develop a general model, which identifies the dependency between valuation parameters in residual income models and the associated structure of earnings information dynamics and accounting conservatism. We test these models by relating the parameters of residual income models to two measures of conservatism, the conventional measure of price-to-book ratio and the recent measure of a C-Score index developed by Khan and Watts (2009) and find that the empirical results accord well with our theoretical predictions.
JEL Classification: M41
Suggested Citation: Suggested Citation