Valuation Weights, Linear Dynamics and Accounting Conservatism: An Empirical Analysis

25 Pages Posted: 27 Feb 2013

See all articles by David J. Ashton

David J. Ashton

University of Bristol - Department of Economics

Pengguo Wang

Xfi, University of Exeter

Date Written: January/February 2013

Abstract

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 an analytical model, which identifies the dependency between valuation weights in residual income models and the associated structure of earnings information dynamics and accounting conservatism. In contrast to many earlier studies, we find strong evidence of conservatism in our reformulation of the linear dynamics. We proceed to test our predictions of the dependency of the weights on 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 in the case of the former but not the latter measure.

Keywords: equity valuation, accounting conservatism, book value, residual income models

Suggested Citation

Ashton, David John and Wang, Pengguo, Valuation Weights, Linear Dynamics and Accounting Conservatism: An Empirical Analysis (January/February 2013). Journal of Business Finance & Accounting, Vol. 40, Issue 1-2, pp. 1-25, 2013, Available at SSRN: https://ssrn.com/abstract=2225660 or http://dx.doi.org/10.1111/jbfa.12001

David John Ashton

University of Bristol - Department of Economics ( email )

8 Woodland Road
Bristol BS8 ITN
United Kingdom
+44 (0)117 928 8423 (Phone)

Pengguo Wang

Xfi, University of Exeter ( email )

Streatham Court
Exeter, EX4 4PU
United Kingdom

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