Conservatism and the Ohlson Model
38 Pages Posted: 6 May 2010 Last revised: 4 Jun 2010
Date Written: June 2010
In this paper, we develop a framework for evaluating the impact of conservative accounting on the structure of residual income models of equity valuation. This affords a theoretical model of the signs and sizes of the valuation weights attached to book values, earnings and dividends as a function of conservatism. We proceed to generalize our model of conservatism and are able to show theoretically the likely numerical impact of conservatism on book values, price-earnings ratios and under valuations produced by residual income models. We investigate empirically the dependency of these valuation weights on conservatism using US data over the period 1963-2006 and find that they accord well with the theory developed. Finally, we explore the associated linear information dynamics and find strong evidence that the time-series properties of abnormal earnings are consistent with our model of accounting conservatism.
Keywords: Accounting conservatism, Equity valuation, Residual income models, Linear information dynamics
JEL Classification: M41
Suggested Citation: Suggested Citation