A theoretical analysis connecting conservative accounting to the cost of capital |
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| Affiliation: | 1. Haas School of Business, University of California, Berkeley, United States;2. Graduate School of Business, Columbia University, United States;1. Emory University, USA;2. The Chinese University of Hong Kong, Shenzhen, China;1. Smeal College of Business, Pennsylvania State University, University Park, PA 16802, USA;2. U.S. Securities and Exchange Commission, 100 F Street NE, Washington, DC 20549, USA;3. Eberly College of Science, Pennsylvania State University, University Park, PA 16802, USA;1. Duke University, USA;2. Cornell University, USA |
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| Abstract: | We connect conservative accounting to the cost of capital by developing an accounting model within an asset pricing framework. The model has three distinctive features: (1) transaction-cycle-conformity, where the book value equals the value of cash at the beginning and the end of a cash-to-cash transaction cycle; (2) a revenue recognition principle, where uncertainty affects the amount of revenues recognized; (3) a matching principle, where expenses are matched with revenue with a conservative bias due to uncertainty. We demonstrate how the growth rate of expected earnings, the accruals-to-cash ratio, and the expected earnings yield relate to the expected stock return. |
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| Keywords: | Conservative accounting Risk and return Earnings growth Accruals Earnings yield M41 G12 |
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