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

See all articles by Stephen H. Penman

Stephen H. Penman

Columbia University - Columbia Business School, Accounting, Business Law & Taxation

Xiao-Jun Zhang

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

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

Penman, Stephen H. and Zhang, Xiao-Jun, Connecting Book Rate of Return to Risk and Return: The Information Conveyed by Conservative Accounting (July 1, 2020). 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 University - Columbia Business School, Accounting, Business Law & Taxation ( email )

665 West 130 Street
Kravis Hall
New York, NY 10027
United States
(212) 854-9151 (Phone)

Xiao-Jun Zhang

University of California, Berkeley ( 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

Do you have negative results from your research you’d like to share?

Paper statistics

Downloads
1,067
Abstract Views
9,289
Rank
38,334
PlumX Metrics