Reporting Conservatism, Loss Reversals, and Earnings-Based Valuation

50 Pages Posted: 22 Oct 2002

See all articles by Peter R. Joos

Peter R. Joos

INSEAD

George A. Plesko

University of Connecticut School of Business

Date Written: September 1, 2002

Abstract

We study the determinants of losses and their increased frequency over time to understand their implications for the use of financial statements in valuation. We find the properties of losses change between 1971-2000 both in terms of the cash flow and accruals components. Departing from prior research, we explicitly model the estimated likelihood of loss reversal. We find firms estimated to be least likely to reverse have unusually large negative cash flows and accruals, comprised of relatively large amounts of R&D expenditures and Special Items. We also find the market assesses both the effect of reporting conservatism and the attractiveness of abandoning the investment in the firm when it prices losses. We interpret this as evidence that the probability of loss reversal summarizes financial information useful to investors and serves as a proxy for the earning power of assets when the firm reports a loss.

Keywords: Earnings, Losses, Conservatism, Cash Flows, Accruals

JEL Classification: G12, M41, D21

Suggested Citation

Joos, Peter R. and Plesko, George A., Reporting Conservatism, Loss Reversals, and Earnings-Based Valuation (September 1, 2002). MIT Sloan Working Paper No. 4262-02. Available at SSRN: https://ssrn.com/abstract=330660 or http://dx.doi.org/10.2139/ssrn.330660

Peter R. Joos

INSEAD ( email )

1 Ayer Rajah Avenue
Singapore, 138676
Singapore

George A. Plesko (Contact Author)

University of Connecticut School of Business ( email )

School of Business
Storrs, CT 06269-2041
United States
860-486-6421 (Phone)

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