Accounting Conservatism and the Relation Between
Returns and Accounting Data
Peter Easton
The Ohio State University and The University of Melbourne
and
Jinhan Pae
Queen’s University
May 2003
We thank Ashiq Ali, Bruce Billings, Keji Chen, Dan Dhaliwal, Jerry Feltham, Rick Morton, Jim Ohlson,
Gord Richardson, Greg Sommers, Mark Trombley, Bill Schwartz, Philip Stocken, two anonymous referees,
and workshop participants at the University of British Columbia, Florida State University, Nyenrode
University, the Ohio State University, the University of Arizona, and the 2001 American Accounting
Association annual meetings, for helpful comments on earlier drafts.
Accounting Conservatism and the Relation Between Returns and Accounting Data
Abstract
The study adds change in cash investments and change in lagged operating assets
to the regression of returns on earnings levels and earnings changes examined in Easton
and Harris (1991). The model in Feltham and Ohlson (1996) suggests that a positive
coefficient on change in cash investments captures conservatism associated with
investments in positive net present value projects the effects of which will not flow into
the accounting statements until the expected future benefits are realized. A positive
coefficient on change in lagged operating assets implies accounting conservatism
associated with the application of accounting rules (such as expensing rather than
capitalizing R&D expenditures) to operating assets in place. Our empirical results are, in
general, consistent with the predictions from Feltham and Ohlson (1996). We examine
differences in conservatism across samples with different market to book ratios, we
compare firms with non-negative returns with firms with negative returns, we compare
firms reporting losses with firms reporting profits, and we examine firms in different
industries, firms with different levels of research and development expenditure, different
amounts of depreciation, different amounts of advertising expense, and firms that adopt
LIFO inventory valuation compared with those that adopt an alternative to LIFO.
1
1. Introduction
The study adds change in cash investments and change in lagged operating assets
to the regression of returns on earnings levels and earnings changes examined in Easton
and Harris (1991).1 We show that change in cash investments and change in lagged
operating assets have incremental explanatory power (over earnings levels and earnings
changes) for returns suggesting that accounting is conservative in the Feltham and Ohlson
(1996) sense.
The model in Feltham and Ohlson (1996) suggests that a positive coefficient on
change in lagged operating assets implies accounting conservatism associated with the
application of accounting rules (such as expensing rather than capitalizing R&D
expenditures) to operating assets in place. A positive coefficient on change in cash
investments captures conservatism associated with investments in positive net present
value projects the effects of which will not flow into the accounting statements until the
expected future benefits are realized. Our empirical results are, in general, consistent
with the predictions from Feltham and Ohlson (1996) providing evidence of accounting
conservatism.
Feltham and Ohlson (1995, 1996) generalize and extend Ohlson (1995) by
introducing the notion of accounting conservatism (defined as market value exceeding
book value in the long run). With few exceptions empirical studies of the relation
between returns and accounting data rely on Ohlson (1995) implicitly ignoring the effects
of conservatism. Easton and Harris (1991) show that deflated (by beginning-of-period
stock price) earnings levels and deflated earnings changes have significant explanatory
power for annual returns. Their regression is implicitly based on Ohlson (1995) in which
accounting is assumed to be unbiased (that is, the market value of equity equals the book
value of equity in the long run). However, the current disparity between market value of
equity and book value of equity suggests that accounting is not likely to be unbiased.
Empirical tests are performed on a sample of 53,554 firm-year observations from
1988 to 2001. The mean of the year-by-year estimates of the coefficients on change in
1
We also add lagged dividends in all of our analyses as another explanatory variable for returns. The focus
in Easton and Harris (1991) is on earnings changes and earnings levels although they note their model
suggests that dividends should be included as an additional explanatory variable. Easton and Harris (1991)
observe that inclusion of lagged dividends does not affect their inferences.
2
lagged operating assets is not significantly different from zero while the mean of the
estimate of the coefficient on change in cash investments is 0.266 (t-statistic of 7.56).
The significantly positive estimate of the coefficient on change in cash investments
suggests that accounting is conservative, consistent with the results in Ahmed, Morton,
and Schaefer (2000).
We find that accounting conservatism as defined in Feltham and Ohlson (1996) is
more pronounced for firms where the market value of operating assets is high relative to
their book value (this is consistent with use of the ratio of the market value of common
equity to the book value of common equity as a proxy for accounting conservatism in
Beaver and Ryan (2000)).2 Our empirical analyses demonstrate that the magnitude of the
estimates of the coefficients on change in cash investments and change in lagged
operating assets increase as the price to book ratio increases. Industry-specific analysis
shows evidence of varying degrees of accounting conservatism across industries.
Accounting conservatism is particularly evident in the pharmaceutical industry.
Following Basu (1997) who suggests that accounting will be more (less)
conservative for firms with good (bad) news over the fiscal period, we seek evidence of a
difference in accounting conservatism between firms with non-negative returns (good
news) and firms with negative returns (bad news). Consistent with Basu (1997), the
estimate of the coefficient on change in cash investments is significantly less for firms
with net bad news (negative returns) than the estimate of the coefficient on change in
cash investments for firms with net good news (non-negative returns). The estimate of the
coefficient on change in lagged operating assets is significantly negative for firms with
negative returns while it is not significantly different from zero for firms with nonnegative returns. In the Feltham and Ohlson (1995, 1996) model lagged operating assets
have negative weight if there is under-depreciation of these assets. That is, for these
firms where the market assessed the net change in value as negative, accounting recorded
a smaller decline in value. The negative estimate of this coefficient suggests that the
accruals of firms with net bad news are not sufficient to make accounting earnings fully
2
Feltham and Ohlson (1995, 1996) assume that financial assets are marked-to-market and hence
conservatism arises in the accounting for operating assets. It follows that the ratio of the market value of
net operating assets to the book value of net operating assets (as opposed to the ratio of the market value of
common equity to the book value of common equity) may be a more appropriate indicator of conservatism.
We show that results are very similar for samples formed on either of these market-to-book ratios.
3
reflect the decline of firm value in years of negative returns.
Hayn (1995) focuses on the news in earnings rather than the news in returns to
motivate an analysis of the returns/earnings relation for firms reporting losses compared
with firms reporting profits. In order to examine the effects of losses on accounting
conservatism, we partition the sample into profit and loss firms. Our empirical analyses
suggest that there is no difference in accounting conservatism associated with the
application of accounting rules between firms reporting losses and firms reporting profits.
The estimates of the coefficients on change in cash investments are positive for both
profit and loss firms consistent with the notion that cash investments are generally in
positive net present value projects.
Several studies have examined whether accounting is on average conservative.
Even though the generally positive difference between market value and book value of
equity suggests that accounting is likely to be conservative, the extant empirical studies
based on Feltham and Ohlson (1995, 1996) do not provide convincing evidence.
Accounting conservatism is usually examined by estimating either the Feltham and
Ohlson (1995) information dynamics or the implied valuation function.3 Contrary to the
general belief that accounting is conservative, empirical studies based on the information
dynamics generally provide evidence that is consistent with aggressive accounting
(Dechow, Hutton, and Sloan 1999; Myers 1999; Ahmed, Morton, and Schaefer 2000).
The results of empirical studies of the valuation relation are mixed. Myers (1999)
provides empirical evidence consistent with unbiased or aggressive accounting while
Ahmed, Morton, and Schaefer (2000) report empirical results consistent with
conservative accounting.4
In this paper, we seek evidence of conservatism using the valuation relation rather
than the information dynamics.5 We provide empirical evidence of accounting
3
Ohlson (1995) and Feltham and Ohlson (1995, 1996) model value relevant information through a set of
Markovian processes in which current information is sufficient for prediction of future value relevant
information. The information dynamics refer to the sets of Markovian processes assumed in Ohlson (1995)
and Feltham and Ohlson (1995, 1996).
4
Under conservative accounting, the coefficient on the book value of equity should (in a price-levels
regression) be greater than one. Myers (1999) reports that the coefficient on the book value of equity is less
than one (see his Table 4 and 5). Ahmed, Morton and Schaefer (2000) regress goodwill (the difference
between market value and book value of equity) on residual operating earnings, lagged operating assets,
and cash investments. Their significant positive coefficient on lagged operating assets is evidence of
conservative accounting.
5
The information dynamics in Feltham and Ohlson (1995, 1996) and Ohlson (1995) are a means to the end
4
conservatism using the return specification rather than the levels specification: the
empirical results based on the return specification are less susceptible to scale effects,
omitted variables, and multicollinearity. We show that the degree of accounting
conservatism varies with the ratio of market value to book value and it differs across
industries, we demonstrate the different effects of accounting conservatism associated
with accounting rules and accounting conservatism associated with investment in positive
net present value projects, and we show some consistency between the empirical
implications gleaned from the Feltham and Ohlson (1995, 1996) notion of conservatism
and other notions of conservatism in the extant literature.
The paper proceeds as follows. In section 2, we develop an empirical regression
model that is implied by Feltham and Ohlson (1996). Section 3 describes the data and the
sample selection procedure. Section 4 reports the results of the empirical analysis. We
summarize these results and draw conclusions in section 5.
2. Model
Our empirical regression model is based on Feltham and Ohlson (1996) rather
than Ohlson (1995). In later analyses we consider the empirical implications of Feltham
and Ohlson (1995). Feltham and Ohlson (1996) explicitly model the possibility of
conservative accounting whereas Ohlson (1995) implicitly assumes unbiased accounting.
As in Feltham and Ohlson (1996), accounting is defined as conservative (unbiased) if the
value of a firm is expected to exceed (equal) the firm's book value of equity in the long
run.
The basic ingredients of the Feltham and Ohlson (1996) model are:
(1) the cash flow dynamics: 6
of understanding the mapping from accounting data to security prices. We focus on this mapping. Of
course, the mapping will be affected by the assumed dynamics. Empirical analysis of the information
dynamics is, in essence, examination of the descriptive validity of a key assumption akin to testing the
capital asset pricing model by determining whether multi-variate normality is descriptive of stock returns.
Like the literature on the capital asset pricing model, we focus on the implications of the model rather than
the assumptions. Lack of descriptive validity of the information dynamics suggests that we should only use
the model as guidance for our empirical analyses. We will return to this point in the next section of the
paper.
6
For the sake of simplicity, the information dynamics in our paper do not include dynamics for other
information. In Feltham and Ohlson (1995, 1996), other information is modeled to represent information
5
c~rt 1  crt  kcit  ~1t 1
c~it 1 
cit  ~2t 1
(CFD)
(2) the present value of cash flow relation:

Vt   R  E t [c~t  ]
(PVCF)
 1
and (3) the operating asset relation:
oat  oat 1  oxt  ct
 oat 1  oact  cit
(OAR)
where  > 0,  [0,1),  [0, R), crt and cit are cash receipts and cash investments, ct (
crt - cit) is net cash flows, Vt is the market value of operating assets at date t, R is one plus
the riskless rate of return (r), oat is net operating asset at time t, oxt is operating earnings,
and oact is operating accruals for period t.
Assumptions CFD, PVCF, and OAR are sufficient to derive the following
valuation relation:
Vt  oat   1oxta   2 cit  R(  1)oat 1  oact 
where   [ R   ]1 , 1   ,  2  [  1]
(1)
R
, and oxta ( oxt  ( R  1)oat 1 ) is
R 
residual operating income.
Invoking the Feltham and Ohlson (1995) assumption that financial assets are
valued at market, equation (1) may be re-written as:
pt  bt   1 xta   2 cit  R(  1)oat 1  oact 
(2)
where pt is the market value of equity at time t, pt is the book value of equity at time t and
xta is residual earnings for period t (that is, xt – (R-1)bt-1).7
about future revenues and/or growth opportunities, which may not be reflected in the accounting variables.
We argue that the effect of the omission of other information in the return setting used in our empirical
analyses will be minimal since, in this setting other information is less likely (compared with the pricelevels setting) to be highly correlated with the variables that capture the effect of accounting conservatism.
Other studies have introduced other information variables in the Feltham and Ohlson (1995, 1996) setting.
For example, Begley and Feltham (2002) demonstrate how to extract other information using one-year and
two-year-ahead analysts’ forecasts. Liu and Ohlson (2000) show that analysts’ forecasts about one-yearahead operating earnings and operating assets can be used to infer other information. Myers (1999) uses
sales backlogs as a proxy for other information. Of course, as a practical matter there are an infinite array
of potential other information variables.
7
The assumption that financial assets are valued at market value is also frequently made in the finance
literature (see, for example, Brealey and Myers 2002). Of course, there are many financial assets and
obligations for which this assumption may not hold. Allowing for this possibility in the Feltham and
Ohlson (1996) framework would require introducing an accounting depreciation rate for financial assets
6
Feltham and Ohlson (1996) examine the effect of accounting accruals on the
relation between accounting numbers and firm value by focusing on the relation between
operating accruals (the accounting measure of change in value of operating assets –
referred to generically as depreciation) and beginning of period book value of operating
assets. In the interest of parsimony, they invoke the simplifying assumption that operating
accruals are a constant proportion (1-  ) of beginning of period operating assets.
Although this proportion (1-  ) may be viewed as an accrual that has the characteristics
of the declining balance depreciation method, it will also capture any change in the
accounting measure of the value of operating assets. For example, research and
development costs that are expensed immediately have a  of zero. In general,  may be
viewed as the weighted average of the accounting measures of change in value. Under
this simplifying assumption, Feltham and Ohlson (1996) suggest the following value
relation:
pt  bt  1 xta   2 cit   3 oat 1
(3)
where  3  R(   ) .
Taking first differences and rearranging yields:
pt  dt  pt 1  (1  r1 ) xt  R1xt  r1dt 1   2 cit  3oat 1
(4)
The coefficient on change in lagged operating assets captures the effect of accounting
value added, and the coefficient on change in cash investments captures the effect of
economic value added. We elaborate on this point.
Recall that  3  R(   ) . That is, change in lagged operating assets (oat-1)
has positive weight if there is over-depreciation of these assets (that is, the accounting
that differs from the economic depreciation rate (analogous to (1-) and (1-) for operating assets). Any
difference between these rates would be captured via the estimate of the coefficient on an additional
variable, change in lagged financial assets. Occasionally estimates of this coefficient are significantly
positive when change in lagged financial assets is added to the regressions in the latter part of the paper –
the estimates of the coefficients on the remaining variables are not changed significantly. Also, cash
investments in financial assets may be in positive net present value projects suggesting that a positive
estimate of coefficient on change in cash investments may also reflect conservatism in the accounting for
these assets. These investments are, however, generally viewed as means of holding reserves for future
investments in operations and are thus unlikely to be positive net present value. As a practical matter,
Compustat data does not permit us to separate cash investments in operations and cash investments in
financial assets. Hence, our estimate of the coefficient on change in cash investments captures positive net
present value investments in both of these asset types.
7
depreciation rate (1-) is greater than the economic depreciation rate (1-)).8 In other
words, if assets have been over-depreciated in the past, future earnings will be higher
because there will be less depreciation to match against revenues. Since this higher
earnings is due to the accounting policy (depreciation rate), the consequent positive
residual income reflects only accounting value added – not economic value added. If
   , operating assets are recorded at market value – and thus goodwill (the present
value of future residual income) associated with depreciation of beginning operating
assets is zero.
Recall that  2  [  1]
R
. That is, current investments cit have positive
R 
weight if they have positive NPV (that is,  > 1). Note that cash investments at the end
of the current period do not affect residual income of the current period (this captures the
reality that new investments do not affect accounting earnings until products are sold or a
service is provided). The effect of current investments is on residual income of future
periods. That is, positive residual income in future periods may reflect economic value
added in past periods but positive residual income in the current period does not reflect
economic value added in the current period.
To summarize, if accounting is conservative as in Feltham and Ohlson (1995,
1996), change in cash investments, change in lagged operating assets, and lagged
dividends should be included as additional variables in the return, earnings levels, and
earnings changes regression as in equation (4). The lack of consideration of accounting
conservatism may affect the estimates of the coefficients on earnings levels and earnings
changes because change in cash investments, change in lagged operating assets and/or
lagged dividends may be correlated with these variables.
Most of our analyses are based on regressions that are the empirical analogue of
equation (4) with all variables scaled by beginning market value of equity: 9
ret jt   0   1
x jt
p jt 1
 2
x jt
p jt 1
 3
d jt 1
p jt 1
 4
ci jt
p jt 1
 5
oa jt 1
p jt 1
  jt ,
(5)
The term depreciation is used in the general sense of “change in value”.
Consistent with all papers that use Ohlson (1995) and/or Feltham and Ohlson (1995, 1996) we estimate
the relation between the variables identified in equation (4) for a cross-section of firms. However, we note
that these models are based on a single-firm economy and the implications for a multi-firm economy are
not addressed. It follows that the conclusions from our empirical tests must be interpreted with this
shortcoming in mind.
8
9
8
where ret jt  ( p jt  d jt  p jt 1 ) / p jt 1 .10 The subscript j denotes an observation for firm j.
The cross-sectional regressions are run separately for each year of available data.  4
captures the effect of conservatism due to future positive NPV projects, and  5 captures
the effect of conservatism due to accounting rules. The coefficients on earnings levels,
earnings changes, and lagged dividends are all predicted to be positive.11
3. Data Selection and Sample Description
Initially, we collect all Compustat firm-year observations from fiscal years 1988
through 2001 for which we have complete data for the following items. Return ( ret t ) is
obtained from CRSP by compounding monthly returns during the fiscal period. We use
comprehensive income as a measure of earnings ( xt ). Comprehensive income is net
income (#172) minus preferred dividends (#19) plus the change in value of marketable
securities (#238) plus the change in cumulative foreign currency translation adjustment
(#230). The change in comprehensive income is denoted by xt. Dividends ( d t ) are the
sum of dividends to common shareholders (item #21) and net capital contributions. Net
capital contributions are purchases of common and preferred stock (item#115) minus
sales of common and preferred stock (item#108). Operating assets ( oat ) are book value
10
Equation (4) suggest that restrictions could be placed on the relations among the coefficients 1 ,  2 and
 3 . The coefficient estimates sometimes differ significantly when these restrictions are imposed
suggesting that the Feltham and Ohlson (1996) model is not descriptively valid and thus our empirical
model is mis-specified. It follows that conclusions regarding the significance of the estimates of the
coefficients on change in cash investments and change in lagged operating assets must be made with the
accompanying caveat that the results may reflect mis-specification of the model that we use to motivate
their inclusion in the returns regression.
11
Unlike Easton and Harris (1991) we use returns of the fiscal period rather than returns for the twelve
months ending three months after fiscal year end. This choice is motivated by the fact that the focus in our
analysis is a comparison of the change in value of the assets as captured in the accounting data with the
change in the value of these assets as captured by the market in the same period. Lagging returns by three
months introduces the possibility that the accounting data conveys information to the market. Although
this introduces concepts that go beyond the model in Feltham and Ohlson (1996), we repeated all analyses
using returns lagged three months. All conclusions are qualitatively the same. Easton and Harris (1991)
also employ abnormal returns as another return metric. In our empirical regression, the use of abnormal
returns ( ( p jt  d jt  Rp jt 1 ) / p jt 1 ) rather than raw returns ( ( p jt  d jt  p jt 1 ) / p jt 1 ) will affect the intercept. If the
regression model is well specified and we use raw returns as a return metric, the intercept (  0 ) will be zero.
If we use abnormal returns instead of raw returns, the intercept will be smaller by the estimate of the
“normal return”.
9
of equity ( bt ) minus financial assets ( fat ). Book value of equity (bt) is common equity
(#60) plus preferred treasury stock (#227) minus preferred dividends in arrears (#242).
Financial assets (fat) are cash and short-term investments (#1) plus investments and
advances-others (#32) minus debt in current liabilities (#34) minus long-term debt (#9)
minus preferred stock (#130) plus preferred treasury stock (#227) minus preferred
dividends in arrears (#242) minus minority interest (#38). Cash investments are obtained
from the cash flow statement as the negative of cash flows from investing activities
(#311). 12
The ratio of the market value of operating assets to the book value of operating
assets (V/oa) is the market value of common equity minus financial assets (fat) divided by
the book value of operating assets ((pt - fat)/oat). All variables except the market value of
equity ( p t ), annual stock returns ( ret t ), and ratio of the market value of operating assets
to the book value of operating assets (V/oa) are deflated by the beginning market value of
equity ( pt 1 ). Observations with negative book value of equity or negative book value or
market value of operating assets are excluded. We further delete observations in the top
and bottom one percent of the distribution for any one of the following variables: annual
returns, earnings levels, earnings changes, lagged dividends, change in cash investments,
and change in lagged operating assets in order to mitigate the effect of extreme values.
The final sample is 53,554 firm-year observations, which consist of 37,169 firmyear observations reporting profits (profit firms, hereafter) and 16,385 firm-year
observations reporting losses (loss firms, hereafter) and 28,366 observations with nonnegative returns (good news firms, hereafter) and 25,188 observations with negative
returns (bad news firms, hereafter). The lack of data necessary to measure cash
investments (cit) restricts most of our analysis to the post-1987 period.
Panel A of table 1 reports descriptive statistics for the sample of 53,554 firm-year
observations from 1988 through 2001. The median market value of equity is $128.26
million. Over the 14 years, the mean and median annual raw stock returns are 12.2% and
3.2%, respectively. Median net comprehensive income and the change in net
comprehensive income are 4.3% and 0.4% of the beginning market value of equity.
Median lagged dividends are zero. The decomposition of book value of equity into
12
Nissim and Penman (2001) provide detailed justification and explanation of their methods for measuring
the accounting related variables. We use their definitions and we use the same data sources.
10
operating assets and financial assets shows that firms have on average net financial
obligations; hence operating assets are greater than book value of equity. The positive
change in operating assets (median of 3.8 percent of price) implies that operating assets
are on average increasing. The ratio of the market value of operating assets to the book
value of operating assets is generally greater than one although, for about 18 percent of
the sample, market value of operating assets is less than their book value.
Panel B of table 1 reports descriptive statistics for profit and loss sub-samples.
Profit firms are, on average, bigger than loss firms. The median market values of equity
for profit and loss firms are $214.68 million and $43.51 million, respectively. Loss firms
have, on average, higher market to book (P/B and V/oa) ratios than profit firms. This is
due to both higher market value of equity for profit firms and lower book value of equity
for loss firms.
Panel C of table 1 reports descriptive statistics for firm-years with non-negative
returns (“good” news) and for the firm-years with negative returns (“bad” news). The
median market values of equity for good and bad news firm-years are $232.84 million
and $66.97 million, respectively. Good news firm-years have, on average, higher market
to book (P/B and V/oa) ratios than bad news firms.
Table 2 reports the Pearson and Spearman correlations among key variables. The
correlations between the returns and each of the independent variables are significant at,
at least the 0.01 level. The correlations between change in lagged operating assets and
both earnings changes and change in cash investments are high (-0.250 and –0.217,
respectively) suggesting that multicollinearity may affect the stability of the estimates of
the coefficients on these variables.
4. Empirical Results
4.1. Conservatism in the entire sample
Table 3 summarizes the output from regression (5) for each of years 1988 to 2001.
Conservatism associated with investment in positive NPV projects (economic value
added) is evident in the data. However, there is no evidence of conservatism due to
accounting rules (accounting value added).
The estimate of the coefficient on change in cash investments is significantly
11
positive in every annual regression except year 2001. The mean of these estimates
(0.266) is significantly positive at, at least, the 0.01 level (t-statistic of 7.56). This
evidence is consistent with the notion in Feltham and Ohlson (1996) that conservative
accounting does not reflect the effects of investments in positive net present value
projects until future periods. The estimates of the coefficient on change in cash
investments are significantly positive in 13 of the 14 annual regressions, providing some
comfort that multicollinearity (which may lead to instability of the coefficient estimates)
is not unduly affecting the analyses.
The mean of the estimates of the coefficient on change in lagged operating assets
is not significantly different from zero at conventional levels (t-statistic of –0.59)
suggesting that conservatism associated with over-depreciation of assets in place has no
incremental explanatory power for returns over earnings, earnings changes, and lagged
dividends.
The mean of the adjusted R2 is 11.5%. The estimates of the coefficients on
earnings, earnings changes, and lagged dividends are all positive as predicted. The mean
estimates of the coefficients on earnings and earnings changes are significant at the 0.01
level. However, the mean of the estimates of the coefficients on lagged dividends is not
significantly different from zero.
4.2. A Comparison with Easton and Harris (1991)
We now investigate the effect of the omission of change in cash investments and
change in lagged operating assets from regression (5). The results of this investigation are
reported in table 4. The estimate of the coefficient on earnings levels in the simple
regression of returns on deflated earnings levels (model M1) is significantly positive at
the 0.01 level (t-statistic of 9.25). The estimate of the coefficient on earnings changes in
the simple regression of returns on deflated earnings changes (model M2) is also
significantly positive at the 0.01 level (t-statistic of 15.37). This result is consistent with
Easton and Harris (1991).13 Next, we regress annual stock returns on both earnings
13
Easton and Harris (1991) report the estimate of 1.02 (with t-statistic of 10.0) on earnings levels and 0.74
(with t-statistics of 0.74) on earnings changes. The sample period and the measures of returns and earnings
of Easton and Harris (1991) are different from this study. Easton and Harris (1991) examined the sample
period from 1968 to 1986, and their returns are measured for a year ending three months after fiscal period.
12
levels and earnings changes (model M3). The mean estimates of the coefficients on
earnings levels and earnings changes are 0.655 and 0.533, respectively, with associated tstatistics of 5.35 and 7.10, respectively.
Consistent with the Ohlson (1995) model, we add lagged dividends to earnings
levels and earnings changes as explanatory variables for returns (model M4). The
addition of lagged dividends does not materially increase the adjusted R2, and the
estimate of the coefficient on lagged dividends is not significantly different from zero at
the 0.05 level.
Addition of change in cash investments and change in lagged operating assets
increases the average adjusted R2 from 10.2% (in model M4) to 11.5% (in model M5).
The estimate of the coefficient on earnings levels decreases from 0.628 to 0.593 (with a tstatistic for the difference between these coefficient estimates of -2.95) while the estimate
of the coefficient on earnings changes increases from 0.545 to 0.620 (with a t-statistic for
the difference between these coefficient estimates of 1.22).
4.3. The Current Market to Book Ratio as a Proxy for Conservatism
Even though conservatism is defined in Feltham and Ohlson (1995, 1996) as an
asymptotic relation between market value of equity and book value of equity in the long
run, the current price to book ratio may be used as an indication of the degree of
conservatism if it is expected to persist into the future. We note, however, that Feltham
and Ohlson (1995, 1996) assume that financial assets are marked-to-market and hence
conservatism arises in the accounting for operating assets. It follows that the ratio of the
market value of net operating assets to the book value of net operating assets (as opposed
to the ratio of the market value of common equity to the book value of common equity)
may be a more appropriate indicator of conservatism.
We partition the sample each year into deciles based on the ratio of the market
value of net operating assets measured as the market value of equity minus the book
value of financial assets (that is, pt  fat ) to book value of operating assets (that is, oat )
and we examine whether the current ratio of market value of net operating assets to book
This paper uses comprehensive income as a measure of earnings.
13
value of net operating assets is related to accounting conservatism as we have defined it
in our regression (5). We expect that the higher the current ratio of market value of net
operating assets to book value of net operating assets, the more conservative the
accounting. All of the analyses in this section of the paper have been repeated using the
ratio of the market value of common equity to book value of common equity with very
similar results.
Table 5 summarizes the output from regression (5) conducted within deciles of
market value of net operating assets to book value of net operating assets. Decile 1
includes firms with the lowest ratios of market value of net operating assets to book value
of net operating assets, and decile 10 includes firms with the highest ratios.14 If the
current market to book ratio is a good proxy for accounting conservatism, the coefficients
on the change in cash investments and change in lagged operating assets will increase as
we move from decile 1 to decile 10.
Table 5 reports that the median market to book (V/oa) ratio is less than one for
deciles 1 and 2, implying that accounting is more likely to be aggressive.15 For deciles 3
and higher, the median market to book (V/oa) ratios are greater than one, implying that
accounting is more likely to be conservative. The estimate of the coefficient on change in
lagged operating assets is significantly negative for decile 1 consistent with the change in
value represented by the accruals being less than the change in value reflected in returns.
Accounting conservatism in the higher V/oa deciles is seen in significantly positive
estimates of the coefficients on change in lagged operating assets for deciles 4 and higher.
The estimates of the coefficients on change in cash investments increase
monotonically from 0.033 for the decile with lowest V/oa to 1.131 for the decile with
highest V/oa.
To summarize, the higher estimates of the coefficients of change in lagged
operating assets and change in cash investments for higher price-to-book ratio samples
confirm our prediction that the current market to book ratio appears to capture
conservatism as modeled in Feltham and Ohlson (1996).
14
In the discussion of the results in table 5, we will refer to the ratio of the market value of net operating
assets to book value of net operating assets as the market to book ratio.
15
That is, the accounting estimate of change in value is greater than the market’s assessment of change in
value for these firms.
14
4.4. Conservatism and Industry
Table 7 reports medians of key variables by industry. Utilities and firms in the
chemicals and transportation industries have larger market value of equity. The median
annual stock returns are positive in all industries other than the mining and construction,
computers, and services industries. The median net income is positive in all industries
other than the pharmaceutical industry. The median price to book ratio is greater than one
for all industries. The pharmaceutical industry has the highest median price to book ratio
followed by the computer industry. The positive median change in cash investments for
all industries suggests increasing cash investments in operations over this time period.
Consistent with increasing cash investments, the median change in lagged operating
assets is positive for all industries.
Table 8 reports the results from regression (5) conducted at the industry level.
The estimates of the coefficients on change in cash investments (consistent with
investment in positive net present value projects) are significantly positive in all
industries other than agriculture, mining and construction, food, chemicals,
transportation, insurance and real estate, and others. The estimates of the coefficients on
change in lagged operating assets are not significantly different from zero with the
exception of pharmaceuticals (t-statistic of 5.41), extractive industries (t-statistic of 2.53),
and durable manufactures (t-statistic of -2.65). Note that the pharmaceutical industry has
the highest median V/oa (7.268). These results are consistent with those in Table 5.
4.5. Positive Returns vs. Negative Returns and Conservatism
Basu (1997) observes that the explanatory power of earnings for returns differs
according to whether news is on average good (that is, returns of the fiscal period are
positive) or news is on average bad (negative returns). In order to examine this effect,
firms are partitioned according to the sign of their fiscal period returns and regression (5)
is re-estimated for the two partitions of the data.
Panel A of table 9 reports that the estimate of the coefficient on earnings in the
regression of returns on earnings for non-negative returns firms is not significantly
different from zero (0.073) and (also consistent with Basu (1997)) panel B of table 9
15
reports that the estimate of this coefficient for firms with negative returns is significantly
positive (0.418 with a t-statistic of 9.39). The estimate of the coefficient on earnings
changes is significant for both good news and bad news firms.
The results from regression (5) show that for firms with net good news (panel A)
the estimate of the coefficient on change in lagged operating assets is not significantly
different from zero at the 0.05 level. However, the estimate of the coefficient on change
in lagged operating assets is significantly negative (t-statistic of –2.49) for firms with net
bad news (panel B). In the Feltham and Ohlson (1996) model, lagged operating assets
have negative weight if there is under-depreciation of these assets (that is, the accounting
depreciation rate (1-) is less than the economic depreciation rate (1-)). That is, for
these firms where the market has assessed the net change in value as negative, accounting
recorded a smaller decline in value.
The estimate of the coefficient on change in cash investments is significantly
positive for both the non-negative and the negative returns sample suggesting that there is
accounting conservatism associated with firms investing in positive net present projects.
However, the estimate of the coefficient on change in cash investments for firms with net
good news (0.228) is significantly greater (t-statistic of difference (un-tabulated) of 6.13)
than the estimate of this coefficient for firms with net bad news (0.024). This result is
consistent with the notion that firms with net good news have a greater tendency to invest
in positive net present value projects. The result is also consistent with Basu’s (1997)
idea that accounting is less conservative for firms with net bad news than firms with net
good news.
4.6. Profit vs. Loss and Conservatism
Hayn (1995) focuses on the news in earnings rather than the news in returns to
motivate an analysis of the returns/earnings relation for firms reporting losses compared
with firms reporting profits. In order to examine the effects of losses on accounting
conservatism, we partition the sample into profit and loss firms.
Consistent with Hayn (1995), Panel A of table 10 reports that the estimate of the
coefficient on earnings in the simple regression of returns on earnings for profit firms is
significantly positive (3.57) at, at least, the 0.001 level (t-statistic of 19.71). Panel B of
16
table 9 reports that the estimate of this coefficient for loss firms is not significantly
negative (-0.025 with a t-statistic of -0.41). The estimate of the coefficient on earnings
changes is significant for both profit and loss firms.
The results from regression (5) show that the estimate of the coefficient on change
in lagged operating assets is not significantly different from zero for both profit and loss
firms (t-statistics of -0.70 and -0.83, respectively). In other words, there is no difference
in accounting conservatism associated with the application of accounting rules (t-statistic
of difference (un-tabulated) of 0.05) between profit and loss firms.
The estimate of the coefficient on change in cash investments is significantly
positive for both profit and loss firms (t-statistics of 7.19 and 6.73, respectively). The
evidence suggests that cash investments for both profit and loss firms are generally in
positive net present value projects. The estimate of the coefficient on change in cash
investments for profit firms (0.216) is significantly less (t-statistic for difference (untabulated) of -2.63) than the estimate of this coefficient for loss firms (0.294). In other
words, cash investments undertaken by loss firms have a greater tendency to have
positive net present values than those undertaken by profitable firms. At first glance this
may seem strange. We suggest that this reflects the nature of the firms that report losses
during our sample period – it is evident from descriptive statistics reported in table 1 that
loss firms have, on average, higher price to book ratios than profit firms. This is
consistent with loss firms being in an early stage in their life cycle and/or having more
growth potential.
4.7. Accounting Methods and Conservatism
In this subsection, we examine the relation between accounting methods
employed by firms and conservatism as modeled by Feltham and Ohlson (1996). We
consider research and development intensity, depreciation rate, advertising intensity, and
the choice of LIFO inventory accounting method (Beaver and Ryan, 2000 and Ahmed,
Morton, and Schaefer 2000) as indicators of conservatism associated with accounting
methods. We partition our sample into quartiles by research and development intensity
(research and development costs divided by sales), depreciation rate (deprecation and
amortization expenses divided by the sum of beginning property, plant, and equipment,
17
and intangibles), and advertising intensity (advertising expenses divided by sales). For
inventory accounting method, we partition our sample into firms employing LIFO as a
primary inventory accounting method and others.
Table 11 reports the results of annual regressions for quartiles based on each of
the indicators of conservatism. These analyses are based on samples of firm years that
have data for the respective accounting based indicator. The estimate of the coefficient on
change in lagged operating assets is negative (-0.058) for firms that have low research
intensity while the estimate of this coefficient for firms with high research intensity is
positive (0.017); however, nether of them is significant at the 0.05 level. We do not find
significant differences (t-statistic of 0.92) between the estimate of the coefficient on
change in lagged operating assets for the low research intensity portfolio and the high
research intensity portfolio, suggesting that there is no significant difference in
conservatism associated with application of overall accounting rules. Similarly, we do not
find significant differences in accounting conservatism associated with the application of
accounting rules for depreciation rates, advertising intensity, and inventory accounting
method.
The estimate of the coefficient on change in cash investments is significantly
greater (t-statistic of 4.25) for high research intensity firms than for low research intensity
firms suggesting that research expenditures tend to be positive net present value. The
estimate of the coefficient on change in cash investments is significantly greater (tstatistic of 4.19) for firms with higher depreciation expense than for firms with lower
depreciation expense. A possible explanation for this result may be that higher
depreciation rates suggest that more assets have been acquired recently, consistent with
higher growth via positive net present value investments. The estimate of the coefficient
on change in cash investments is significantly greater (t-statistic of 3.12) for high
advertising intensity firms than for low advertising intensity firms suggesting that
advertising expenditures tend to be positive net present value. The estimate of the
coefficient on change in cash investments is significantly greater (t-statistic of 3.24) for
firms that adopt LIFO than for those that use another inventory valuation methods. In
other words, the degree of accounting conservatism associated with investment in
18
positive net present value projects tends to be greater for these firms.16
4.8 Feltham and Ohlson (1995) and Accounting Conservatism
Both Feltham and Ohlson (1995) and Feltham and Ohlson (1996) incorporate the
possibility of accounting conservatism; however, there are subtle differences in modeling
accounting conservatism. In this sub-section, we examine the implications of Feltham and
Ohlson (1995) for empirical analyses of accounting conservatism. The return regression
model based on Feltham and Ohlson (1995) can be expressed as follows:
ret jt   0  1
x jt
p jt 1
 2
x jt
p jt 1
 3
d jt 1
p jt 1
 4
oa jt
p jt 1
  jt ,
(6)
In regression (6), accounting conservatism is captured by the change in operating
assets (oat), which may be compared with regression (5) based on Feltham and Ohlson
(1996), in which accounting conservatism is captured by change in cash investments and
change in lagged operating assets. Note that, in regression (6), there is no distinction
between conservatism due to accounting rules and conservatism associated with
investment in positive net present value projects. The change in operating assets can be
thought of as the sum of the effects of change in cash investments and change in lagged
operating assets since operating assets can be expressed as the weighted sum of lagged
operating assets and current cash investments by applying the operating asset relation
(OAR) and by representing operating accruals as a multiple of lagged operating asset
(Feltham and Ohlson (1996)):
oat  oat 1  oact  cit
 oat 1  (  1)oat 1  cit
 oat 1  cit
The return model based on Feltham and Ohlson (1995) can be used to assess the
overall effect of accounting conservatism, and provide a simple framework to control for
accounting conservatism. Since it does not require the decomposition of change in
16
The results in section 4.3 suggest that the market to book ratio is a good proxy for accounting
conservatism. The median market to book ratio is higher for firms with high research intensity, high
depreciation rates, and high advertising intensity than for firms with low research intensity, low
depreciation rate, and low advertising intensity. However, the median market to book ratio for firms
employing LIFO as a primary inventory valuation method (1.49) is lower than that for firms employing
other inventory valuation methods (1.71).
19
operating assets into lagged operating assets and cash investments, we can extend our
analysis back to earlier years in which cash flow statements are not available.
Table 12 reports the results of the examination of accounting conservatism based
on the specification of Feltham and Ohlson (1995) for each of years from 1972 through
2001. Consistent with the results in table 5, the estimate of the coefficient on the change
in operating assets (0.05) is significantly positive at the 0.01 level, implying that
accounting is on average conservative. The estimates of the coefficients on earnings
level, earnings changes, and lagged dividends are positive as in table 4.
5. Summary
Based on Feltham and Ohlson (1996), we identify two types of accounting
conservatism: conservatism due to accounting rules and conservatism associated with
investments in positive net present value projects. We add change in lagged operating
assets to the Easton and Harris (1991) regression to capture conservatism due to
accounting rules (accounting value added), and change in cash investments to capture
conservatism associated with investments in positive net present value projects
(economic value added). Consistent with conventional wisdom, we find that accounting is
conservative. This result has implications for the Easton and Harris (1991) regression of
annual stock returns on earnings levels and earnings changes. We show that the estimates
of the coefficients on earnings levels and earnings changes are affected by accounting
conservatism, and that there is an improvement in the explanatory power with the
inclusion of the variables associated with conservatism.
We show that the effect of accounting conservatism is related to the ratio of the
market value of net operating assets to the book value of net operating assets. Industry
analyses show that there is a wide variation in the degree of accounting conservatism
across industries. We find that accounting for pharmaceutical industry is more
conservative than accounting for other industries. We find that accounting tends to be
more conservative for firms reporting losses than for firms reporting profits, and
consistent with Basu (1997) we find that accounting tends to be less conservative for
firms with negative returns than for firms with non-negative returns.
20
References
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Valuation of Accounting Numbers: Evidence of the Feltham-Ohlson (1996) Model.
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Basu, S. 1997. The Conservatism Principle and the Asymmetric Timeliness of Earnings.
Journal of Accounting and Economics: 3-37.
Beaver, W. H. and S. G. Ryan 2000. Biases and Lags in Book Value and Their Effects on
the Ability of the Book-to-Market Ratio to Predict Book Return on Equity. Journal of
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Feltham, G. A. and J. Ohlson 1996. Uncertainty Resolution and the Theory of
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22
Table 1: Descriptive Statistics for Key Variables
Panel A: All Firms (#obs=53,554)
Variable
Mean Std. Dev.
pt
1,915.20 10,903.55
rett
0.122
0.621
xt
0.002
0.162
xt
-0.001
0.165
dt-1
-0.021
0.104
0.009
0.233
cit
bt
0.664
0.535
fat
-0.348
1.021
oat
1.012
1.259
oat
0.076
0.429
0.067
0.288
oat-1
V/oa
15.343 649.810
P/B
4.006
49.247
Q1
30.54
-0.253
-0.028
-0.037
-0.013
-0.053
0.319
-0.520
0.300
-0.022
-0.010
1.119
1.186
Median
128.26
0.032
0.043
0.004
0.000
0.005
0.550
-0.117
0.692
0.038
0.041
1.672
1.898
Panel B: Profit and Loss Firms
Profit Firms (#obs = 37,169)
Variable
Mean
Q1
Median
Q3
pt
2,467.37 50.69
214.68 980.87
rett
0.209
-0.130
0.113
0.401
xt
0.076
0.040
0.066
0.097
0.033
-0.007
0.012
0.041
xt
dt-1
-0.006 -0.006
0.001
0.030
cit
0.020
-0.037
0.009
0.069
bt
0.688
0.370
0.586
0.868
fat
-0.318 -0.503 -0.128
0.080
oat
1.006
0.356
0.727
1.311
0.115
0.001
0.056
0.158
oat
oat-1
0.074
-0.004
0.045
0.133
V/oa
11.596 1.171
1.696
3.040
P/B
3.254
1.258
1.904
3.109
Q2
656.39
0.342
0.081
0.034
0.023
0.066
0.856
0.082
1.320
0.138
0.136
3.281
3.315
Min.
Max.
0.00
508,329.5
-0.955
7.316
-2.182
0.535
-1.404
2.332
-1.087
0.324
-2.167
1.822
0.000
11.638
-47.822
7.142
0.000
49.343
-15.616
29.604
-3.933
3.134
0.001
86,102.5
0.000
6,620.0
Loss Firms (#obs = 16,385)
Mean
Q1
Median
Q3
662.62 13.58
43.51
171.27
-0.075 -0.487 -0.219
0.124
-0.166 -0.215 -0.100
-0.040
-0.078 -0.158 -0.060
0.001
-0.054 -0.073 -0.004
0.000
-0.016 -0.092 -0.006
0.057
0.608
0.208
0.439
0.814
-0.417 -0.577 -0.085
0.086
1.026
0.170
0.581
1.349
-0.012 -0.120 -0.002
0.077
0.051
-0.030
0.030
0.146
23.843 0.990
1.585
4.381
5.709
0.985
1.873
4.122
23
Panel C: Good News and Bad News Firms
Good News Firms (#obs = 28,366)
Variable
Mean
Q1
Median
Q3
pt
2,559.38 54.45
232.84 1,035.50
rett
0.507
0.144
0.318
0.630
xt
0.041
0.024
0.066
0.100
xt
0.028
-0.009
0.014
0.050
dt-1
-0.009 -0.007
0.000
0.031
0.028
-0.039
0.012
0.084
cit
bt
0.750
0.385
0.629
0.946
fat
-0.337 -0.534 -0.118
0.107
oat
1.087
0.348
0.766
1.410
oat
0.105
-0.012
0.049
0.161
0.055
-0.017
0.036
0.123
oat-1
V/oa
21.767 1.325
2.028
4.054
P/B
4.430
1.501
2.321
3.970
Bad News Firms (#obs = 25,188)
Mean
Q1
Median
Q3
1,189.75 18.15
66.97
313.54
-0.312 -0.465 -0.274
-0.127
-0.042 -0.080
0.012
0.053
-0.033 -0.069 -0.012
0.015
-0.034 -0.028 -0.001
0.012
-0.013 -0.066 -0.001
0.048
0.567
0.259
0.467
0.744
-0.361 -0.503 -0.115
0.062
0.928
0.251
0.613
1.213
0.044
-0.036
0.026
0.115
0.080
-0.004
0.047
0.151
8.108
0.957
1.337
2.437
3.528
0.935
1.495
2.555
pt is the market value of equity (Compustat annual data item #199 x #25). rett is the annual stock return obtained by
compounding CRSP monthly returns over the fiscal period. xt is comprehensive income calculated as net income
(#172) minus preferred dividends (#19) plus the change in marketable securities adjustment (#238) plus the change in
cumulative translation adjustment (#230). xt is the change in comprehensive income. dt-1 is the sum of cash dividends
to common shareholders (#21) and net capital contributions. Net capital contributions include purchases of common
and preferred stock (#115) minus sales of common and preferred stock (#108). Operating assets (oat) is calculated as
book value of equity (bt), minus financial assets (fat). bt is common equity (#60) plus preferred treasury stock (#227),
minus preferred dividends in arrears (#242). fat is cash and short-term investments (#1) plus investments and advancesothers (#32), minus debt in current liabilities (#34) minus long-term debt (#9), minus preferred stock (#130), plus
preferred treasury stock (#227), minus preferred dividends in arrears (#242), minus minority interest (#38.). oat is the
change in operating assets. Cash investment (cit) is the negative of cash flows from investing activities (#311). cit is
the change in cash investments. V/oa is the ratio of the market value of operating assets to the book value of operating
assets. The market value of operating assets is calculated as the market value of equity minus financial assets (pt – fat).
P/B is price to book ratio (pt divided by bt). All variables except for pt, rett, V/oa, and P/B are deflated by beginning
market value of equity (pt-1).
24
Table 2: Pearson and Spearman Correlations among key variables
pt
pt
rett
xt
xt
dt-1
cit
oat-1
V/oa
0.283
(<0.01)
0.235
(<0.01)
0.068
(<0.01)
0.218
(<0.01)
0.064
(<0.01)
0.012
(0.01)
0.326
(<0.01)
rett
0.045
(<0.01)
0.424
(<0.01)
0.349
(<0.01)
0.148
(<0.01)
0.140
(<0.01)
-0.068
(<0.01)
0.328
(<0.01)
xt
0.043
(<0.01)
0.214
(<0.01)
0.527
(<0.01)
0.286
(<0.01)
0.116
(<0.01)
0.052
(<0.01)
-0.043
(<0.01)
xt
0.005
(0.29)
0.216
(<0.01)
0.469
(<0.01)
-0.010
(0.03)
0.049
(<0.01)
-0.163
(<0.01)
0.123
(<0.01)
dt-1
0.062
(<0.01)
0.054
(<0.01)
0.187
(<0.01)
0.005
(0.27)
-0.005
(0.25)
-0.103
(<0.01)
-0.219
(<0.01)
cit
0.004
(0.35)
0.107
(<0.01)
0.077
(<0.01)
-0.014
(<0.01)
0.022
(<0.01)
-0.180
(<0.01)
0.074
(<0.01)
oat-1
-0.006
(0.15)
-0.052
(<0.01)
0.079
(<0.01)
-0.250
(<0.01)
-0.093
(<0.01)
-0.217
(<0.01)
V/oa
0.006
(0.20)
0.018
(<0.01)
-0.004
(0.41)
0.002
(0.69)
-0.011
(0.01)
0.003
(0.49)
-0.005
(0.21)
-0.157
(<0.01)
a
Pearson correlations above the diagonal, Spearman correlations below the diagonal (two tailed p values in
parentheses)
b
pt is the market value of equity (Compustat annual data item #199 x #25). rett is the annual stock return obtained by
compounding CRSP monthly returns over the fiscal period. xt is comprehensive income calculated as net income
(#172) minus preferred dividends (#19), plus the change in marketable securities adjustment (#238), plus the change in
cumulative translation adjustment (#230). xt is the change in comprehensive income. dt-1 is the sum of cash dividends
to common shareholders (#21) and net capital contributions. Net capital contributions include purchases of common
and preferred stock (#115), minus sales of common and preferred stock (#108). Operating assets (oat) is book value of
equity (bt) minus financial assets (fat). bt is common equity (#60) plus preferred treasury stock (#227), minus preferred
dividends in arrears (#242). fat is cash and short-term investments (#1) plus investments and advances-others (#32),
minus debt in current liabilities (#34), minus long-term debt (#9), minus preferred stock (#130), plus preferred treasury
stock (#227), minus preferred dividends in arrears (#242), minus minority interest (#38.). oat is the change in
operating assets. Cash investment (cit) is the negative of cash flows from investing activities (#311). cit is the change
in cash investments. V/oa is the ratio of the market value of operating assets to the book value of operating assets. The
market value of operating assets is the market value of equity minus financial assets (pt – fat). All variables except for
pt, rett, and V/oa are deflated by beginning market value of equity (pt-1).
25
Table 3: Accounting Conservatism: Annual OLS Regressions of Returns on the
Independent Variables suggested by the Feltham and Ohlson (1996) Model
Coefficient estimates with t-statistics in parentheses
Year
#obs
Int.
xt
xt
dt-1
cit
oat-1 Adj. R2
1988
666
0.126
1.164
0.276
-0.060
0.121
-0.050
0.199
(7.62)
(9.51)
(2.05) (-0.52)
(2.16) (-0.80)
1989
3,285
0.125
0.712
0.311
0.103
0.158
-0.032
0.120
(15.61) (13.31) (5.74)
(1.00)
(5.25) (-1.54)
1990
3,440
-0.112
0.783
0.262
-0.084
0.147
-0.028
0.127
(-16.42) (15.46) (5.23) (-0.89)
(4.66) (-1.13)
1991
3,513
0.377
0.363
0.568
-0.397
0.386
0.069
0.080
(30.46) (5.57)
(9.32) (-3.05)
(7.91)
(1.94)
1992
3,648
0.119
0.516
0.507
0.360
0.329
-0.063
0.126
(15.05) (9.47) (10.00) (4.12)
(7.93) (-2.04)
1993
3,943
0.197
0.676
0.583
-0.094
0.443
-0.001
0.105
(21.46) (9.20)
(8.32) (-1.12)
(9.19) (-0.03)
1994
4,263
-0.035
0.817
0.407
0.319
0.217
-0.061
0.150
(-5.68) (14.43) (7.14)
(5.90)
(6.33) (-1.95)
1995
4,464
0.251
0.317
1.034
-0.087
0.373
-0.064
0.090
(25.66) (4.07) (12.51) (-1.05)
(8.56) (-1.60)
1996
4,716
0.127
0.738
0.598
0.364
0.423
0.044
0.125
(16.41) (11.49) (8.97)
(4.33) (12.69) (1.25)
1997
4,869
0.150
1.153
0.409
0.346
0.338
0.101
0.181
(20.29) (17.74) (5.80)
(5.93) (11.68) (3.07)
1998
4,739
-0.052
0.536
0.603
0.284
0.125
-0.093
0.076
(-6.85)
(7.88)
(8.78)
(4.08)
(3.73) (-2.65)
1999
4,455
0.295
-0.560
1.210
-0.366
0.387
-0.068
0.041
(18.04) (-4.86) (10.82) (-2.50)
(6.76) (-1.30)
2000
4,228
0.007
0.746
0.651
0.588
0.232
0.082
0.111
(0.65)
(8.90)
(7.29)
(4.67)
(5.46)
(2.06)
2001
3,325
0.123
0.343
0.443
0.366
0.044
0.023
0.082
(11.40) (6.85)
(9.08)
(4.74)
(1.20)
(0.74)
Mean
3,825
0.121
0.593
0.562
0.117
0.266
-0.010
0.115
t-value
(3.33)
(5.25)
(7.76)
(1.46)
(7.56) (-0.59)
The dependent variable is annual stock returns obtained by compounding CRSP monthly returns over the fiscal period.
xt is comprehensive income calculated as net income (#172) minus preferred dividends (#19), plus the change in
marketable securities adjustment (#238), plus the change in cumulative translation adjustment (#230). xt is the change
in comprehensive income. dt-1 is the sum of cash dividends to common shareholders (#21) and net capital contributions.
Net capital contributions are purchases of common and preferred stock (#115) minus sales of common and preferred
stock (#108). Operating assets (oat) is book value of equity (bt) minus financial assets (fat). bt is common equity (#60)
plus preferred treasury stock (#227) minus preferred dividends in arrears (#242). fat is cash and short-term investments
(#1), plus investments and advances-others (#32), minus debt in current liabilities (#34), minus long-term debt (#9),
minus preferred stock (#130), plus preferred treasury stock (#227), minus preferred dividends in arrears (#242), minus
minority interest (#38.). oat is the change in operating assets. Cash investment (cit) is the negative of cash flows from
investing activities (#311). cit is the change in cash investments. All independent variables are deflated by beginning
market value of equity (pt-1).
26
Table 4: Accounting Conservatism: Mean of Annual OLS Regressions
Coefficient estimates with t-statistics in parentheses
Model
M1
Int.
Coef.
0.119
t-value (3.19)
M2
Coef.
0.125
t-value (3.42)
M3
Coef.
0.119
t-value (3.23)
M4
Coef.
0.123
t-value (3.39)
M3 Coef. = M4 Coef.:
M5
Coef.
0.121
t-value (3.33)
M4 Coef. = M5 Coef.:
xt
0.911
(9.25)
0.655
(5.35)
0.628
(5.46)
(-2.04)
0.593
(5.25)
(-2.95)
xt
0.871
(15.37)
0.533
(7.10)
0.545
(7.48)
(1.74)
0.562
(7.76)
(1.22)
dt-1
cit
oat-1
Adj. R2
0.083
0.059
0.100
0.120
(1.54)
0.117
(1.46)
0.102
0.266
(7.56)
-0.010
(-0.59)
0.115
Coefficients are means of annual regressions over the period 1988-2001, and t-values in parentheses are based on the
standard error of the mean (Fama and MacBeth 1973, Bernard 1987). The dependent variable is annual stock returns
obtained by compounding CRSP monthly returns over the fiscal period. xt is comprehensive income calculated as net
income (#172) minus preferred dividends (#19), plus the change in marketable securities adjustment (#238), plus the
change in cumulative translation adjustment (#230). xt is the change in comprehensive income. dt-1 is the sum of cash
dividends to common shareholders (#21) and net capital contributions. Net capital contributions are purchases of
common and preferred stock (#115) minus sales of common and preferred stock (#108). Operating assets (oat) is book
value of equity (bt) minus financial assets (fat). bt is common equity (#60) plus preferred treasury stock (#227), minus
preferred dividends in arrears (#242). fat is cash and short-term investments (#1) plus investments and advances-others
(#32), minus debt in current liabilities (#34), minus long-term debt (#9), minus preferred stock (#130), plus preferred
treasury stock (#227), minus preferred dividends in arrears (#242), minus minority interest (#38.). oat is the change in
operating assets. Cash investment (cit) is the negative of cash flows from investing activities (#311). cit is the change
in cash investments. All independent variables are deflated by beginning market value of equity (pt-1).
27
Table 5: Conservatism and the ratio of the Market Value of Operating Assets to the
Book Value of Operating Assets (V/oa): Mean of Annual OLS Regressions
Coefficient estimates with t-statistics in parentheses
V/oa
Decile Median
1
0.67
2
0.95
3
1.12
4
1.29
5
1.53
6
1.87
7
2.40
8
3.40
9
5.60
10
16.90
Int.
xt
xt
dt-1
cit
oat-1
Adj. R2
-0.162
(-4.19)
-0.087
(-2.24)
-0.034
(-0.83)
0.020
(0.56)
0.056
(1.88)
0.092
(2.95)
0.142
(4.32)
0.173
(4.60)
0.292
(4.79)
0.419
(4.58)
0.483
(6.41)
0.511
(9.50)
0.563
(6.94)
0.718
(6.20)
0.744
(6.44)
0.819
(5.45)
0.902
(5.92)
1.015
(6.75)
0.743
(3.64)
0.553
(1.93)
0.127
(2.89)
0.329
(8.55)
0.374
(4.83)
0.415
(3.62)
0.539
(6.35)
0.674
(5.14)
0.721
(6.94)
1.039
(7.28)
1.008
(5.21)
0.661
(4.13)
0.689
(7.91)
0.644
(8.81)
0.625
(5.57)
0.588
(6.96)
0.532
(7.72)
0.400
(4.41)
0.410
(3.61)
0.277
(2.91)
0.138
(1.14)
-0.310
(-1.30)
0.033
(2.46)
0.080
(3.51)
0.089
(2.29)
0.182
(4.77)
0.234
(3.64)
0.380
(6.86)
0.370
(4.23)
0.661
(6.24)
0.829
(6.10)
1.131
(7.40)
-0.103
(-5.20)
-0.040
(-1.69)
0.002
(0.08)
0.104
(2.64)
0.177
(2.77)
0.331
(4.03)
0.275
(2.78)
0.717
(5.25)
0.650
(2.72)
0.415
(2.63)
0.204
0.193
0.199
0.188
0.180
0.186
0.168
0.198
0.138
0.103
Coefficients are means of annual regressions over the period 1988-2001, and t-values in parentheses are based on the
standard error of the mean (Fama and MacBeth 1973, Bernard 1987). The dependent variable is annual stock returns
obtained by compounding CRSP monthly returns over the fiscal period. xt is comprehensive income calculated as net
income (#172) minus preferred dividends (#19), plus the change in marketable securities adjustment (#238), plus the
change in cumulative translation adjustment (#230). xt is the change in comprehensive income. dt-1 is the sum of cash
dividends to common shareholders (#21) and net capital contributions. Net capital contributions are purchases of
common and preferred stock (#115) minus sales of common and preferred stock (#108). Operating assets (oat) is book
value of equity (bt) minus financial assets (fat). bt is common equity (#60) plus preferred treasury stock (#227) minus
preferred dividends in arrears (#242). fat is cash and short-term investments (#1) plus investments and advances-others
(#32), minus debt in current liabilities (#34), minus long-term debt (#9), minus preferred stock (#130), plus preferred
treasury stock (#227), minus preferred dividends in arrears (#242), minus minority interest (#38.). oat is the change in
operating assets. Cash investment (cit) is the negative of cash flows from investing activities (#311). cit is the change
in cash investments. All independent variables are deflated by beginning market value of equity (pt-1). V/oa is the ratio
of the market value of operating assets to the book value of operating assets. The market value of operating assets is the
market value of equity minus financial assets (pt – fat).
28
Table 6: Industry Composition
Industry
Agriculture
Mining and Construction
Food
Textiles and Printing
Chemicals
Pharmaceuticals
Extractive Industries
Durable Manufacturers
Computers
Transportation
Utilities
Retail
Financial Institutions
Insurance and Real Estate
Services
Others
Total
Mean
Primary SIC codes
1-999
1000-1999, excluding 1300-1399
2000-2111
2200-2790
2800-2824, 2840-2899
2830-2836
2900-2999, 1300-1399
3000-3999, excluding 3570-3579
and 3670-3679
7370-7379, 3570-3579, 3670-3679
4000-4899
4900-4999
5000-5999
6000-6411
6500-6999
7000-8999, excluding 7370-7379
9000 and above
# firmyears
237
1,401
1,399
3,211
1,440
2,364
2,287
13,570
% of
Obs.
0.44
2.62
2.61
6.00
2.69
4.41
4.27
25.34
6,992
2,828
2,698
6,308
1,438
1,948
5,097
336
53,554
3,347
13.06
5.28
5.04
11.78
2.69
3.64
9.52
0.63
100.02
6.25
29
Table 7 Median of Key Variables by Industry
Industry[a]
Agriculture
Mining and Construction
Food
Textiles and Printing
Chemicals
Pharmaceuticals
Extractive Industries
Durable Manufacturers
Computers
Transportation
Utilities
Retail
Financial Institutions
Insurance and Real Estate
Services
Others
a
pt
168.67
140.72
167.17
189.66
360.33
140.29
201.19
88.21
99.11
412.65
632.75
105.66
171.74
128.51
79.67
48.81
rett
0.026
-0.047
0.054
0.045
0.043
0.009
0.053
0.025
-0.031
0.065
0.107
0.007
0.123
0.093
-0.007
0.000
xt
0.035
0.037
0.050
0.058
0.053
-0.038
0.034
0.046
0.015
0.038
0.073
0.050
0.064
0.056
0.034
0.023
xt
0.002
0.003
0.004
0.004
0.002
-0.001
0.004
0.004
0.003
0.002
0.004
0.007
0.011
0.006
0.006
0.001
dt-1
0.004
0.000
0.012
0.013
0.018
-0.007
0.000
0.000
-0.006
0.000
0.041
0.000
0.001
0.007
-0.001
0.000
cit oat-1
0.000 0.044
0.003 0.060
0.004 0.036
0.003 0.045
0.001 0.034
0.003 0.012
0.020 0.049
0.003 0.038
0.003 0.027
0.010 0.061
0.008 0.062
0.007 0.065
0.011 0.064
0.001 0.013
0.007 0.059
0.002 0.038
V/oa
1.724
1.326
1.845
1.433
1.796
7.268
1.513
1.596
2.990
1.682
1.268
1.421
1.738
2.067
1.702
1.656
See table 6 for the definition of industry.
pt is the market value of equity (Compustat annual data item #199 x #25). rett is the annual stock return obtained by
compounding CRSP monthly returns over the fiscal period. xt is comprehensive income calculated as net income
(#172) minus preferred dividends (#19) plus the change in marketable securities adjustment (#238) plus the change in
cumulative translation adjustment (#230). xt is the change in comprehensive income. dt-1 is the sum of cash dividends
to common shareholders (#21) and net capital contributions. Net capital contributions are purchases of common and
preferred stock (#115) minus sales of common and preferred stock (#108). Operating assets (oat) is book value of
equity (bt) minus financial assets (fat). bt is common equity (#60) plus preferred treasury stock (#227) minus preferred
dividends in arrears (#242). fat is cash and short-term investments (#1) plus investments and advances-others (#32),
minus debt in current liabilities (#34), minus long-term debt (#9), minus preferred stock (#130), plus preferred treasury
stock (#227), minus preferred dividends in arrears (#242), minus minority interest (#38.). oat is the change in
operating assets. Cash investment (cit) is the negative of cash flows from investing activities (#311). cit is the change
in cash investments. V/oa is the ratio of the market value of operating assets to the book value of operating assets. The
market value of operating assets is the market value of equity minus financial assets (pt – fat). All variables except for
pt, rett, and V/oa are deflated by beginning market value of equity (pt-1).
30
Table 8: Conservatism and Industry: Mean of Annual OLS Regressions
Industry[a]
Agriculture
Mining and
Construction
Food
Textiles and
Printing
Chemicals
Pharmaceuticals
Extractive Industries
Durable
Manufacturers
Computers
Transportation
Utilities
Retail
Financial
Institutions
Insurance and Real
Estate
Services
Others
a
Int.
0.112
(1.70)
0.051
(1.27)
0.049
(1.28)
0.074
(1.67)
0.082
(1.85)
0.175
(2.76)
0.087
(1.49)
0.118
(2.93)
0.169
(2.26)
0.169
(2.98)
0.050
(1.55)
0.102
(2.63)
0.144
(2.86)
0.099
(3.12)
0.110
(3.21)
0.045
(1.19)
xt
0.872
(3.40)
0.828
(4.52)
1.236
(4.28)
0.775
(5.18)
1.026
(4.37)
0.111
(0.42)
0.857
(4.21)
0.712
(6.30)
0.666
(7.81)
0.274
(0.92)
0.939
(3.00)
0.868
(8.92)
0.954
(3.44)
0.512
(2.91)
0.804
(5.39)
0.736
(2.80)
xt
1.037
(1.74)
0.066
(0.32)
0.932
(3.85)
0.318
(2.76)
0.254
(1.18)
0.609
(3.38)
0.104
(1.18)
0.548
(6.09)
0.677
(8.03)
0.473
(3.25)
0.259
(1.58)
0.529
(4.42)
0.665
(5.29)
0.102
(0.75)
0.478
(4.14)
-0.077
(-0.35)
dt-1
-0.229
(-0.54)
0.384
(2.18)
0.745
(2.69)
-0.050
(-0.27)
-0.378
(-0.71)
0.183
(0.84)
0.122
(0.84)
0.148
(1.79)
0.241
(1.67)
0.017
(0.10)
0.077
(0.47)
0.219
(1.98)
0.255
(1.02)
0.150
(1.09)
0.014
(0.10)
0.084
(0.17)
cit
oat-1
0.096
(0.53)
0.060
(0.77)
0.109
(1.32)
0.132
(2.94)
0.113
(1.11)
0.883
(4.64)
0.266
(5.10)
0.191
(7.22)
0.444
(4.42)
0.296
(2.80)
0.187
(3.37)
0.271
(5.09)
0.159
(2.67)
0.041
(0.97)
0.250
(4.83)
0.257
(1.37)
-0.080
(-0.26)
-0.055
(-1.27)
0.110
(0.99)
-0.046
(-1.66)
-0.101
(-1.33)
0.435
(5.41)
0.084
(2.53)
-0.071
(-2.65)
0.004
(0.08)
0.057
(1.07)
0.059
(1.18)
-0.032
(-0.85)
-0.023
(-0.50)
-0.108
(-1.86)
-0.014
(-0.40)
0.057
(0.39)
Adj. R2
0.275
0.141
0.266
0.142
0.102
0.122
0.147
0.129
0.133
0.118
0.190
0.150
0.136
0.110
0.130
0.158
See table 6 for the definition of industry.
Coefficients are means of annual regressions over the period 1988-2001, and t-values in parentheses are based on the
standard error of the mean (Fama and MacBeth 1973, Bernard 1987). The dependent variable is annual stock returns
obtained by compounding CRSP monthly returns over the fiscal period. xt is comprehensive income calculated as net
income (#172) minus preferred dividends (#19) plus the change in marketable securities adjustment (#238) plus the
change in cumulative translation adjustment (#230). xt is the change in comprehensive income. dt-1 is the sum of cash
dividends to common shareholders (#21) and net capital contributions. Net capital contributions are purchases of
common and preferred stock (#115) minus sales of common and preferred stock (#108). Operating assets (oat) is book
value of equity (bt) minus financial assets (fat). bt is common equity (#60) plus preferred treasury stock (#227) minus
preferred dividends in arrears (#242). fat is cash and short-term investments (#1) plus investments and advances-others
(#32), minus debt in current liabilities (#34), minus long-term debt (#9), minus preferred stock (#130), plus preferred
treasury stock (#227), minus preferred dividends in arrears (#242), minus minority interest (#38.). Cash investment (cit)
31
is the negative of cash flows from investing activities (#311). oat is the change in operating assets. cit is the change
in cash investments. All independent variables are deflated by beginning market value of equity (pt-1).
32
Table 9: Conservatism and the Sign of Returns: Means of Annual OLS Regressions
Panel A: Good News Firms (non-negative returns)
Model
Int.
xt
dt-1
xt
M1
Coef.
0.485
0.073
t-value (11.47) (0.73)
M2
Coef.
0.476
0.549
t-value (11.63)
(13.97)
M3
Coef.
0.478
-0.194
0.635
t-value (11.57) (-1.64) (10.12)
M4
Coef.
0.472
-0.088
0.583
-0.702
t-value (11.43) (-0.81) (10.31) (-6.29)
M3 Coef. = M4 Coef.
(6.64) (-4.65)
M5
Coef.
0.466
-0.110
0.619
-0.685
t-value (11.25) (-1.03) (10.91) (-6.14)
M4 Coef. = M5 Coef.
(-2.70) (3.64)
Panel B: Bad News Firms (negative returns)
Model
Int.
xt
xt
M1
Coef.
-0.283
0.418
t-value (-20.58) (9.39)
M2
Coef.
-0.293
0.212
t-value (-21.45)
(8.11)
M3
Coef.
-0.283
0.426
-0.014
t-value (-20.62) (8.99) (-0.76)
M4
Coef.
-0.275
0.385
0.009
t-value (-19.84) (8.87)
(0.52)
M3 Coef. = M4 Coef.
(-4.80) (4.77)
M5
Coef.
-0.274
0.393
-0.003
t-value (-19.78) (9.49) (-0.17)
M4 Coef. = M5 Coef.
(1.42) (-1.84)
dt-1
cit
oat-1
Adj. R2
0.007
0.028
0.034
0.049
0.228
(7.27)
0.015
(1.42)
0.059
cit
oat-1
Adj. R2
0.109
0.026
0.110
0.308
(7.61)
0.299
(7.17)
0.133
0.024
(2.82)
-0.023
(-2.49)
0.135
Coefficients are means of annual regressions over the period 1988-2001, and t-values in parentheses are based on the
standard error of the mean (Fama and MacBeth 1973, Bernard 1987). The dependent variable is annual stock returns
obtained by compounding CRSP monthly returns over the fiscal period. xt is comprehensive income calculated as net
income (#172) minus preferred dividends (#19) plus the change in marketable securities adjustment (#238) plus the
change in cumulative translation adjustment (#230). xt is the change in comprehensive income. dt-1 is the sum of cash
dividends to common shareholders (#21) and net capital contributions. Net capital contributions are purchases of
common and preferred stock (#115) minus sales of common and preferred stock (#108). Operating assets (oat) is book
value of equity (bt) minus financial assets (fat). bt is common equity (#60) plus preferred treasury stock (#227) minus
preferred dividends in arrears (#242). fat is cash and short-term investments (#1) plus investments and advances-others
(#32), minus debt in current liabilities (#34), minus long-term debt (#9), minus preferred stock (#130), plus preferred
treasury stock (#227), minus preferred dividends in arrears (#242), minus minority interest (#38). oat is the change in
operating assets. Cash investment (cit) is the negative of cash flows from investing activities (#311). cit is the change
in cash investments. All independent variables are deflated by beginning market value of equity (pt-1).
33
Table 10: Conservatism and the Sign of Earnings: Means of Annual OLS
Regressions
Panel A: Profit firms
Model
Int.
M1
Coef.
-0.064
t-value (-2.86)
M2
Coef.
0.173
t-value (5.32)
M3
Coef.
-0.052
t-value (-2.20)
M4
Coef.
-0.052
t-value (-2.25)
M3 Coef. = M4 Coef.
M5
Coef.
-0.051
t-value (-2.21)
M4 Coef. = M5 Coef.
Panel b: Loss firms
Model
Int.
M1
Coef.
-0.079
t-value (-1.79)
M2
Coef.
-0.051
t-value (-1.01)
M3
Coef.
-0.078
t-value (-1.77)
M4
Coef.
-0.071
t-value (-1.70)
M3 Coef. = M4 Coef.
M5
Coef.
-0.069
t-value (-1.60)
M4 Coef. = M5 Coef.
xt
3.570
(19.71)
3.165
(16.16)
3.177
(16.06)
(0.94)
3.129
(17.10)
(-2.25)
xt
-0.025
(-0.41)
-0.194
(-2.34)
-0.208
(-2.58)
(-1.73)
-0.222
(-2.67)
(-0.92)
xt
dt-1
cit
oat-1
Adj. R2
0.158
1.162
(11.18)
0.546
(5.07)
0.540
(5.07)
(-0.98)
0.566
(5.34)
(1.58)
-0.106
(-1.55)
-0.101
(-1.60)
0.216
(7.19)
-0.016
(-0.70)
0.180
xt
dt-1
cit
oat-1
Adj. R2
0.003
0.302
(8.42)
0.366
(5.99)
0.376
(6.14)
(1.29)
0.379
(5.73)
(0.16)
0.058
0.169
0.171
0.012
0.019
0.094
(0.83)
0.077
(0.68)
0.024
0.294
(6.73)
-0.017
(-0.83)
0.040
Coefficients are means of annual regressions over the period 1988-2001, and t-values in parentheses are based on the
standard error of the mean (Fama and MacBeth 1973, Bernard 1987). The dependent variable is annual stock returns
obtained by compounding CRSP monthly returns over the fiscal period. xt is comprehensive income calculated as net
income (#172) minus preferred dividends (#19) plus the change in marketable securities adjustment (#238) plus the
change in cumulative translation adjustment (#230). xt is the change in comprehensive income. dt-1 is the sum of cash
dividends to common shareholders (#21) and net capital contributions. Net capital contributions are purchases of
common and preferred stock (#115) minus sales of common and preferred stock (#108). Operating assets (oat) is book
value of equity (bt) minus financial assets (fat). bt is common equity (#60) plus preferred treasury stock (#227) minus
preferred dividends in arrears (#242). fat is cash and short-term investments (#1) plus investments and advances-others
(#32), minus debt in current liabilities (#34), minus long-term debt (#9), minus preferred stock (#130), plus preferred
treasury stock (#227), minus preferred dividends in arrears (#242), minus minority interest (#38.). oat is the change in
operating assets. Cash investment (cit) is the negative of cash flows from investing activities (#311). cit is the change
in cash investments. All independent variables are deflated by beginning market value of equity (pt-1).
34
Table 11: Conservatism and Accounting Based Conservatism Proxies: Mean of
Annual OLS Regressions
Research Intensity (#obs = 29,257)
Portfolio
Int.
xt
xt
dt-1
cit
oat-1
Adj. R2
P1
0.102
0.821
0.473
0.164
0.152
-0.058
0.137
(low)
(2.61)
(9.35)
(6.21)
(2.49)
(4.91)
(-1.73)
P2
0.094
0.820
0.495
0.348
0.172
-0.020
0.139
(2.59)
(5.23)
(3.37)
(3.69)
(4.02)
(-0.70)
P3
0.154
0.796
0.876
0.128
0.397
0.063
0.150
(3.11)
(7.24)
(7.11)
(0.95)
(6.97)
(1.03)
P4
0.137
0.315
0.597
0.007
0.662
0.017
0.086
(high)
(1.85)
(2.92)
(5.49)
(0.04)
(5.33)
(0.23)
P1 Coef. = P4 Coef.
(4.25)
(0.92)
Depreciation Rate (#obs = 43,767)
P1
0.082
0.646
0.271
0.251
0.138
0.006
0.106
(low)
(2.82)
(4.31)
(3.01)
(2.53)
(3.25)
(0.26)
P2
0.095
0.696
0.457
0.232
0.194
0.002
0.122
(3.15)
(8.25)
(9.03)
(3.50)
(6.57)
(0.09)
P3
0.125
0.694
0.663
0.060
0.324
-0.015
0.137
(3.35)
(5.54)
(5.37)
(0.47)
(7.44)
(-0.58)
P4
0.144
0.559
0.648
0.024
0.440
0.005
0.115
(high)
(2.41)
(4.54)
(6.35)
(0.19)
(6.65)
(0.10)
P1 Coef. = P4 Coef.
(4.19)
(-0.02)
Advertising Intensity (#obs = 14,216)
P1
0.150
0.603
0.763
0.340
0.207
-0.063
0.135
(low)
(3.95)
(5.65)
(11.03)
(1.71)
(5.47)
(-1.12)
P2
0.110
0.880
0.491
0.212
0.277
-0.025
0.136
(3.15)
(5.19)
(5.05)
(1.29)
(6.00)
(-0.57)
P3
0.118
0.614
0.573
0.169
0.257
-0.095
0.121
(2.93)
(6.27)
(5.75)
(1.04)
(4.22)
(-2.12)
P4
0.113
0.591
0.793
0.165
0.449
0.021
0.141
(high)
(2.61)
(2.73)
(3.76)
(1.78)
(5.35)
(0.28)
P1 Coef. = P4. Coef
(3.12)
(1.13)
Inventory Accounting Method (#obs = 53,554)
LIFO
0.076
0.851
0.432
0.234
0.104
-0.054
0.143
(2.30)
(6.04)
(4.30)
(2.02)
(2.85)
(-1.46)
Non
0.125
0.592
0.566
0.125
0.282
-0.008
0.114
LIFO
(3.28)
(5.52)
(8.23)
(1.58)
(7.32)
(-0.41)
LIFO Coef. = Non Lifo Coef.
(-3.24)
(-1.02)
Coefficients are means of annual regressions over the period 1988-2001, and t-values in parentheses are based on the
standard error of the mean (Fama and MacBeth 1973, Bernard 1987). Research intensity is measured by research and
development expense (#46) divided by sales (#12). Depreciation rate is measured by depreciation and amortization
expense (#14) divided by the beginning balance of property, plant, and equipment (#8) plus intangibles (#33).
Advertising intensity is measured by advertising expense (#45) dividend by sales (#12). Coefficients are means of
annual regressions over the period 1988-2001, and t-values in parentheses are based on the standard error of the mean
(Fama and MacBeth 1973, Bernard 1987). The dependent variable is annual stock returns obtained by compounding
CRSP monthly returns over the fiscal period. xt is comprehensive income calculated as net income (#172) minus
35
preferred dividends (#19), plus the change in marketable securities adjustment (#238), plus the change in cumulative
translation adjustment (#230). xt is the change in comprehensive income. dt-1 is the sum of cash dividends to common
shareholders (#21) and net capital contributions. Net capital contributions are purchases of common and preferred stock
(#115) minus sales of common and preferred stock (#108). Operating assets (oat) is book value of equity (bt) minus
financial assets (fat). bt is common equity (#60) plus preferred treasury stock (#227), minus preferred dividends in
arrears (#242). fat is cash and short-term investments (#1) plus investments and advances-others (#32), minus debt in
current liabilities (#34), minus long-term debt (#9), minus preferred stock (#130), plus preferred treasury stock (#227),
minus preferred dividends in arrears (#242), minus minority interest (#38.). oat is the change in operating assets. Cash
investment (cit) is the negative of cash flows from investing activities (#311). cit is the change in cash investments.
All independent variables are deflated by beginning market value of equity (pt-1).
36
Table 12: Accounting Conservatism: Mean of Annual OLS Regressions (1972-2001)
Coefficient estimates with t-statistics in parentheses
Model
M1
Int.
Coef.
0.070
t-value
(2.08)
M2
Coef.
0.127
t-value
(3.73)
M3
Coef.
0.078
t-value
(2.30)
M4
Coef.
0.080
t-value
(2.38)
M3 Coef. = M4 Coef.:
M5
Coef.
0.076
t-value
(2.29)
M4 Coef. = M5 Coef.:
xt
1.069
(17.80)
0.861
(11.91)
0.833
(12.23)
(-3.00)
0.804
(11.35)
(-2.58)
xt
0.846
(21.57)
0.409
(8.75)
0.420
(9.46)
(1.95)
0.426
(9.33)
(1.34)
dt-1
oat
Adj. R2
0.125
0.071
0.138
0.176
(2.32)
0.198
(2.71)
0.142
0.050
(3.01)
0.145
Coefficients are means of annual regressions over the period 1972-2001, and t-values in parentheses are based on the
standard error of the mean (Fama and MacBeth 1973, Bernard 1987). The dependent variable is annual stock returns
obtained by compounding CRSP monthly returns over the fiscal period. xt is comprehensive income calculated by net
income (#172) minus preferred dividends (#19) plus the change in marketable securities adjustment (#238) plus the
change in cumulative translation adjustment (#230). xt is the change in comprehensive income. dt-1 is the sum of cash
dividends to common shareholders (#21) and net capital contributions. Net capital contributions include purchases of
common and preferred stock (#115) minus sales of common and preferred stock (#108). Operating assets (oat) is
calculated as book value of equity (bt) minus financial assets (fat). bt is measured by common equity (#60) plus
preferred treasury stock (#227) minus preferred dividends in arrears (#242). fat is measured by cash and short-term
investments (#1) plus investments and advances-others (#32) minus debt in current liabilities (#34) minus long-term
debt (#9) minus preferred stock (#130) plus preferred treasury stock (#227) minus preferred dividends in arrears (#242)
minus minority interest (#38.). oat is the change in operating assets. All independent variables are deflated by
beginning market value of equity (pt-1).