This paper examines how conservative accounting affects the relation between accounting data and firm value. The analysis shows that conservative accounting can be characterized equivalently in terms of book value, earnings, or book rate of return. Furthermore, capitalized earnings generally provide a less biased estimate of equity value than book value does. In addition, firm growth affects the way earnings and book value are combined in valuation. A weighted average of book value and capitalized earnings, with the weight on earnings being an increasing and convex function of growth, yields an asymptotically unbiased estimate of equity value. When growth is positive, the weight on book value is negative.

This study demonstrates that stocks with low book-to-market ratios, also known as glamour stocks, have significantly more positive skewness in their return distributions compared to the return distributions of value stocks with high book-to-market ratios. The premium (discount) investors apply to these glamour (value) stocks also correlates significantly with the difference in return skewness. These findings suggest that the value/glamour-stock puzzle is partially explained by investor preference for positive skewness in stock returns. Such preference for skewness, which is consistent with investors having inverse S-shaped utility functions, is observed in such consumer behaviors as lottery purchases and gambling. This paper further documents significant predictive power of accounting-based measures, such as the book rate of return, with respect to the skewness of stock returns. Data Availability: Data are available from sources identified in the paper.

Forecasting a firm's anticipated financial performance is an essential ingredient in equity valuation. In practice, analysts generally split the forecasting into two stages. The first stage develops relatively detailed forecasts of financial statement line items up to some preselected horizon date. (Casual observation suggests that the horizon rarely exceeds 15 years.) The second stage considers forecasts beyond the horizon date. Analysts now tend simply to extrapolate the selected valuation attribute (like dividends, cash flows, or [residual] earnings). Thus a single growth/ decay parameter determines the expected evolution of the valuation attribute in periods subsequent to the horizon year. On the basis of these two sets of forecasts, analysts then apply present value calculations to estimate a firm's intrinsic value. The portion of value due to the posthorizon period is generally referred to as the continuing (or terminal) value. Textbooks, such as Copeland, Koller, and Murrin [1994] and Damodaran [1994; 1996], illustrate how one implements these valuation approaches. Though the use of a horizon date is always present, its influence on the analysis is less than apparent. The idea behind the horizon concept seems to be that posthorizon simplifications introduce only minor valuation errors. That is, the less refined analysis of information is, in the grand scheme of things, relatively inconsequential and thus costbenefit effective.

Equity valuation, Accrual accounting, Value relevant information, Efficient accounting rules

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.

This paper examines how relative timing affects the quality of financial reports in a staggered reporting system in which some firms report earlier than others. We show that the audit quality of the leading firm exceeds that of the lagger. Investment efficiency also differs systematically across firms, depending on the relative reporting timing as well as the audit market structure. Audit regulations mitigate the misalignment of interests between auditors and investors but limit the effect of information spillovers. We characterize the socially optimal auditing standards and show how and why imposing minimum audit quality requirements complements and/or substitutes for adjusting auditors' legal liability. Overall, we show that a staggered reporting system dominates a simultaneous reporting system in enhancing audit quality and investment efficiency through regulation.