Connecting Book Rate of Return to Risk and Return: The Information Conveyed by Conservative Accounting
58 Pages Posted: 1 Mar 2014 Last revised: 20 Jun 2019
Date Written: June 1, 2019
This paper revises the standard interpretation of the book rate of return as a measure of profitability. Rather, due to conservative accounting, the book rate of return informs about risk and the expected return to the investor. In contrast to asset pricing research where the book rate of return is viewed as positively associated with risk and expected stock returns, this paper demonstrates the opposite: With the effect of conservative accounting, the book rate of return is negatively associated with risk and expected return. Empirical analysis indicates that the market prices equities accordingly. Further, this paper shows how the previously documented positive correlation is due to a misunderstanding of the accounting and its application to asset pricing.
Keywords: book rate of return, conservative accounting, risk and return
JEL Classification: G12, M41
Suggested Citation: Suggested Citation