A substantial literature investigates conditional conservatism, defined as asymmetric accounting recognition of economic shocks (“news”), and how it depends on various market, political, and institutional variables. Studies typically assume the Basu [1997] asymmetric timeliness coefficient (the incremental slope on negative returns in a piecewise‐linear regression of accounting income on stock returns) is a valid conditional conservatism measure. We analyze the measure's validity, in the context of a model with accounting income incorporating different types of information with different lags, and with noise. We demonstrate that the asymmetric timeliness coefficient varies with firm characteristics affecting their information environments, such as the length of the firm's operating and investment cycles, and its degree of diversification. We particularly examine one characteristic, the extent to which “unbooked” information (such as revised expectations about rents and growth options) is independent of other information, and discuss the conditions under which a proxy for this characteristic is the market‐to‐book ratio. We also conclude that much criticism of the Basu regression misconstrues researchers’ objectives.

We document problems in measuring raw and abnormal five-year contrarian portfolio returns. ‘Loser’ stocks are low-priced and exhibit skewed return distributions. Their 163% mean return is due largely to their lowest-price quartile position. A $18-th price increase reduces the mean by 25%, highlighting their sensitivity to micro-structure/liquidity effects. Long positions in low-priced loser stocks occur disproportionately after bear markets and thus induce expected-return effects. A contrarian portfolio formed at June-end earns negative abnormal returns, in contrast with the December-end portfolio. This conclusion is not limited to a particular version of the CAPM.

We examine the “confirmation” hypothesis that audited financial reporting and disclosure of managers' private information are complements, because independent verification of outcomes disciplines and hence enhances disclosure credibility. Committing to higher audit fees (a measure of financial statement verification) is associated with management forecasts that are more frequent, specific, timely, accurate and informative to investors. Because private information disclosure and audited financial reporting are complements, their economic roles cannot be evaluated separately. Our evidence cautions against drawing inferences exclusively from market reactions around “announcement periods” because audited financial reporting indirectly affects information released at other times and through other channels.

This essay provides a retrospective view on our co-authored paper, Ball and Brown (1968). The retrospective was commissioned by Gregory B. Waymire, then President of the American Accounting Association. It describes how we both came to be Ph.D. students at The University of Chicago and set about researching the relation between earnings and share prices. It outlines the background against which we conducted the research, including the largely a priori accounting research literature at the time and the electric atmosphere and radical new ideas then in full bloom at Chicago. We describe some of the principal research choices we made, and their strengths and weaknesses. We also describe the reception our research received and how the related literature subsequently unfolded.

We outline several properties of IFRS that potentially affect the contractibility or the transparency of financial statement information, and hence the use of that information in debt contracts. Those properties include the increased choice among accounting rules IFRS gives to managers, enhanced rule‐making uncertainty, and increased emphasis on fair value accounting. Consistent with reduced contractibility of IFRS financial statement information, we find a significant reduction in accounting‐based debt covenants following mandatory IFRS adoption. The reduction in accounting covenant use is associated with measures of the difference between prior domestic standards and IFRS. Because IFRS adoption changed financial reporting in many ways simultaneously, it is difficult to trace the decline in accounting covenant use to individual IFRS properties, though we report larger declines in accounting covenant use in banks, which have a higher proportion of assets and liabilities that are fair‐valued. Our findings are better explained by reduced contractibility than by increased transparency, which would predict reduced nonaccounting covenant use as well, whereas we observe increases. Overall, we conclude that IFRS rules sacrifice debt contracting usefulness to achieve other objectives, such as provision of accounting information relevant to valuation.

A principal‐components analysis demonstrates that common earnings factors explain a substantial portion of firm‐level earnings variation, implying earnings shocks have substantial systematic components and are not almost fully diversifiable as prior literature has concluded. Furthermore, the principal components of earnings and returns are highly correlated, implying aggregate earnings risks and return risks are related. In contrast to previous studies, the correlation we report between the systematic components of earnings and returns is stable over time. We also show that the earnings factors are priced, in the sense that the sensitivities of securities' returns to the earnings factors explain a significant portion of the cross‐sectional variation in returns, even controlling for return risk. This suggests earnings performance is an underlying source of priced risk. Our evidence that the information sets of returns and earnings are jointly determined implies cash flow risk and return risk are not fully separable, and raises the possibility that it is the common variation of earnings and returns that is priced.

The concept of conditional conservatism (asymmetric earnings timeliness) has provided new insight into financial reporting and stimulated considerable research since Basu (1997). Patatoukas and Thomas (2011) report bias in firm-level cross-sectional asymmetry estimates that they attribute to scale effects. We do not agree with their advice that researchers should avoid conditional conservatism estimates and inferences from research based on such estimates. Our theoretical and empirical analyses suggest the explanation is a correlated omitted variables problem that can be addressed in a straightforward fashion, including fixed-effects regression. Correlation between the expected components of earnings and returns biases estimates of how earnings incorporate the information contained in returns. Further, the correlation varies with returns, biasing asymmetric timeliness estimates. When firm-specific effects are taken into account, estimates do not exhibit the bias, are statistically and economically significant, are consistent with priors, and behave as a predictable function of book-to-market, size, and leverage. Data Availability: Data are publicly available from sources identified in the article.

Book value of equity consists of two economically different components: retained earnings and contributed capital. We predict that book-to-market strategies work because the retained earnings component of the book value of equity includes the accumulation and, hence, the averaging of past earnings. Retained earnings-to-market predicts the cross section of average returns in U.S. and international data and subsumes book-to-market. Contributed capital-to-market has no predictive power. We show that retained earnings-to-market, and, by extension, book-to-market, predicts returns because it is a good proxy for underlying earnings yield (Ball, 1978; Berk, 1995) and not because book value represents intrinsic value.

Accruals are the non-cash component of earnings. They represent adjustments made to cash flows to generate a profit measure largely unaffected by the timing of receipts and payments of cash. Prior research uncovers two anomalies: expected returns increase in profitability and decrease in accruals. We show that cash-based operating profitability (a measure that excludes accruals) outperforms measures of profitability that include accruals. Further, cash-based operating profitability subsumes accruals in predicting the cross section of average returns. An investor can increase a strategy’s Sharpe ratio more by adding just a cash-based operating profitability factor to the investment opportunity set than by adding both an accruals factor and a profitability factor that includes accruals.