Connecting book rate of return to risk and return: the information conveyed by conservative accounting

Stephen H. Penman () and Xiao-Jun Zhang ()
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Stephen H. Penman: Columbia University
Xiao-Jun Zhang: University of California, Berkeley

Review of Accounting Studies, 2021, vol. 26, issue 1, No 11, 423 pages

Abstract: Abstract This paper revises the standard interpretation of the book rate of return as a measure of profitability. Rather, due to conservative accounting, the book rate of return informs about risk and the expected return to the investor. In contrast to asset pricing research, where the book rate of return is viewed as positively associated with risk and expected stock returns, the paper demonstrates the opposite: with the effect of conservative accounting, the book rate of return is negatively associated with risk and expected return. The empirical analysis indicates that the market prices equities accordingly. It also shows how the previously documented positive correlation is due to a misunderstanding of accounting and how the book rate of return enters into asset pricing in a way that is consistent with the accounting.

Keywords: Book rate of return; Conservative accounting; Risk and return; G11; G12; M41 (search for similar items in EconPapers)
Date: 2021
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Citations: View citations in EconPapers (6)

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DOI: 10.1007/s11142-020-09558-5

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