Valuation Weights, Linear Dynamics and Accounting Conservatism: An Empirical Analysis

David J Ashton, Pengguo Wang

Research output: Contribution to journalArticle (Academic Journal)peer-review

4 Citations (Scopus)

Abstract

Residual income models provide an important theoretical link between equity valuation and financial statement variables. While various researchers have developed models of how accounting policy impacts on the structure of these models, empirical support for these models is at best weak and frequently contradictory. In this paper, we develop an analytical model, which identifies the dependency between valuation weights in residual income models and the associated structure of earnings information dynamics and accounting conservatism. In contrast to many earlier studies, we find strong evidence of conservatism in our reformulation of the linear dynamics. We proceed to test our predictions of the dependency of the weights on two measures of conservatism, the conventional measure of price-to-book ratio and the recent measure of a C-Score index developed by Khan and Watts (2009) and find that the empirical results accord well with our theoretical predictions in the case of the former but not the latter measure.
Original languageEnglish
Pages (from-to)1-25
Number of pages25
JournalJournal of Business Finance and Accounting
Volume40
Issue number1/2
Early online date10 Jan 2013
DOIs
Publication statusPublished - Feb 2013

Keywords

  • equity valuation; accounting conservatism; book value; residual income models

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