Profitability news or valuation news? A diagnostic analysis on the different news components in conditional conservatism

Shengmin Hung and Zheng Qiao

Asia-Pacific Journal of Accounting & Economics, 2018, vol. 25, issue 3-4, 496-513

Abstract: The sign of stock return has been widely used to proxy for news in the conditional conservatism model. Under discount cash flow model, firm value changes are caused by either cash flow news or discount rate news. Simply using the sign of stock returns to define good (bad) news can be problematic. Following the classic return decomposition method, this paper decomposes return news into cash flow news and discount rate news. We find that cash flow news component demonstrates consistent results with previous findings. However, with respect to discount rate news, positive return news turns out to be recognized more quickly in earnings. The conventional timeliness asymmetry even disappears in the highest quintile of discount rate news shock magnitude. In additional tests, we also document weakened timeliness asymmetry conditional on a battery of proxy variables for discount rate news. Our findings suggest that we should use stock return sign with caution in conditional conservatism tests, especially when discount rate news shock is large.

Date: 2018
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DOI: 10.1080/16081625.2017.1314189

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Asia-Pacific Journal of Accounting & Economics is currently edited by Yin-Wong Cheung, Hong Hwang, Jeong-Bon Kim, Shu-Hsing Li and Suresh Radhakrishnan

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