Accounting Conservatism, Earnings Persistence, and Pricing Multiples on Earnings

Abstract

SYNOPSIS We examine the effect of accounting conservatism on earnings persistence and the stock market's valuation of earnings. Using a sample of U.S. companies during the period of 1988–2010, we find that firms with more conservative accounting generate less persistent earnings than firms with less conservative accounting. We also document that the pricing multiple on more conservative earnings is smaller than pricing multiples on less conservative earnings. Finally, we show that conditionally conservative earnings are less persistent than unconditionally conservative earnings, and the pricing multiple on earnings is smaller for conditionally conservative earnings than for unconditionally conservative earnings. Our results improve our understanding of the characteristics of conservatively reported earnings. JEL Classifications: M41; C23; D21; G38; N20