The Link between Earnings Conservatism and the Price to Book Ratio

29 Pages Posted: 14 Jun 2004

See all articles by Jinhan Pae

Jinhan Pae

Korea University Business School (KUBS)

Daniel B. Thornton

Smith School of Business at Queen's University

Michael Welker

Queen's University - Queen's School of Business

Multiple version iconThere are 2 versions of this paper

Date Written: February 2005

Abstract

We hypothesize and find: (1) Earnings conservatism, the tendency of firms to recognize bad news in earnings on a more timely basis than good news, is substantially greater in portfolios of firms with lower price-to-book ratios than in portfolios of firms with higher price-to-book ratios;(2) The negative association between earnings conservatism and the price-to-book ratio stems primarily from the accrual component of earnings, not the operating cash flow component of earnings. Our results suggest that studies using earnings-returns associations to investigate cross-sectional or time-series differences in earnings conservatism risk drawing erroneous inferences unless the research designs control for cross-sectional or time-series variation in price-to-book ratios.

Keywords: Accounting conservatism, earnings, accruals, returns, price-to-book

JEL Classification: M41, M44, G12

Suggested Citation

Pae, Jinhan and Thornton, Daniel B. and Welker, Michael, The Link between Earnings Conservatism and the Price to Book Ratio (February 2005). Available at SSRN: https://ssrn.com/abstract=556155 or http://dx.doi.org/10.2139/ssrn.556155

Jinhan Pae (Contact Author)

Korea University Business School (KUBS) ( email )

Anam-Dong, Seongbuk-Gu
Seoul 136-701, 136701
Korea

Daniel B. Thornton

Smith School of Business at Queen's University ( email )

143 Union Street, #358
Kingston, Ontario K7L 3N6
Canada
613-328-5213 (Phone)
613-533-2321 (Fax)

HOME PAGE: http://smith.queensu.ca

Michael Welker

Queen's University - Queen's School of Business ( email )

Kingston
Ontario, Ontario K7L 3N6
Canada

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