The Link Between Earnings Conservatism and the Price to Book Ratio

29 Pages Posted: 19 May 2005

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

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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. Contemporary Accounting Research, Vol. 22, No. 3, Fall 2005. Available at SSRN: https://ssrn.com/abstract=722545

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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