Connecting Book Rate of Return to Risk and Return: The Information Conveyed by Conservative Accounting
60 Pages Posted: 1 Mar 2014 Last revised: 20 Jul 2020
Date Written: July 1, 2020
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, the paper demonstrates the opposite: With the effect of conservative accounting, the book rate of return is negatively associated with risk and expected return. The empirical analysis indicates that the market prices equities accordingly. It also shows how the previously documented positive correlation is due to a misunderstanding of accounting and how the book rate of return enters into asset pricing in a way that is consistent with the accounting.
Keywords: book rate of return, conservative accounting, risk and return
JEL Classification: G12, M41
Suggested Citation: Suggested Citation