Valuation: Accounting for Risk and the Expected Return

43 Pages Posted: 14 Oct 2015

See all articles by Stephen H. Penman

Stephen H. Penman

Columbia Business School - Department of Accounting

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Date Written: October 13, 2015


Under accounting principles, the recognition of earnings is path dependent and the path depends on risk resolution: Under the so-called realization principle, earnings are not booked until uncertainty is resolved. In asset pricing terms, the principle means that earnings cannot be recognized until the firm can book a low-beta asset such as cash or a near-cash discounted receivable. If the risk to which this accounting responds is priced risk, the accounting indicates the expected return. This paper connects accounting under this principle to risk and return, summarizes the supporting empirical evidence, and examines the implications for research on the implied cost of capital, cash-flow betas, asset pricing models that imbed accounting numbers, and papers that assume an autoregressive model for the earnings path to infer the expected return. The accounting that captures risk and its resolution also has implications for the unsolved issue of specifying the appropriate accounting for accounting-based valuation models and, indeed, for financial accounting standards.

Suggested Citation

Penman, Stephen H., Valuation: Accounting for Risk and the Expected Return (October 13, 2015). Columbia Business School Research Paper No. 15-89. Available at SSRN: or

Stephen H. Penman (Contact Author)

Columbia Business School - Department of Accounting ( email )

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