A theoretical analysis connecting conservative accounting to the cost of capital

Stephen Penman and Xiao-Jun Zhang

Journal of Accounting and Economics, 2020, vol. 69, issue 1

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.

Keywords: Conservative accounting; Risk and return; Earnings growth; Accruals; Earnings yield (search for similar items in EconPapers)
JEL-codes: G12 M41 (search for similar items in EconPapers)
Date: 2020
References: View references in EconPapers View complete reference list from CitEc
Citations: View citations in EconPapers (15)

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Persistent link: https://EconPapers.repec.org/RePEc:eee:jaecon:v:69:y:2020:i:1:s016541011930031x

DOI: 10.1016/j.jacceco.2019.101236

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