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

See all articles by Stephen H. Penman

Stephen H. Penman

Columbia Business School - Department of Accounting

Xiao-Jun Zhang

University of California, Berkeley - Accounting Group; China Academy of Financial Research (CAFR)

Date Written: June 1, 2019

Abstract

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

Penman, Stephen H. and Zhang, Xiao-Jun, Connecting Book Rate of Return to Risk and Return: The Information Conveyed by Conservative Accounting (June 1, 2019). Columbia Business School Research Paper No. 14-21. Available at SSRN: https://ssrn.com/abstract=2402933 or http://dx.doi.org/10.2139/ssrn.2402933

Stephen H. Penman (Contact Author)

Columbia Business School - Department of Accounting ( email )

3022 Broadway
New York, NY 10027
United States
212-854-9151 (Phone)
212-316-9219 (Fax)

Xiao-Jun Zhang

University of California, Berkeley - Accounting Group ( email )

545 Student Services Building
SPC 1900
Berkeley, CA 94720
United States
(510) 642-4789 (Phone)
(510) 642-4700 (Fax)

China Academy of Financial Research (CAFR)

1954 Huashan Road
Shanghai P.R.China, 200030
China

Register to save articles to
your library

Register

Paper statistics

Downloads
773
Abstract Views
5,141
rank
30,715
PlumX Metrics