CFA Institute

Rising Conservatism: Implications for Financial Analysis

Author(s): Dan Givoly and Carla Hayn
Source: Financial Analysts Journal, Vol. 58, No. 1 (Jan. - Feb., 2002), pp. 56-74
Published by: CFA Institute
Stable URL: http://www.jstor.org/stable/4480369
Accessed: 27-09-2015 07:10 UTC

Your use of the JSTOR archive indicates your acceptance of the Terms & Conditions of Use, available at http://www.jstor.org/page/
info/about/policies/terms.jsp

JSTOR is a not-for-profit service that helps scholars, researchers, and students discover, use, and build upon a wide range of content
in a trusted digital archive. We use information technology and tools to increase productivity and facilitate new forms of scholarship.
For more information about JSTOR, please contact support@jstor.org.

CFA Institute is collaborating with JSTOR to digitize, preserve and extend access to Financial Analysts Journal.

http://www.jstor.org

This content downloaded from 141.216.78.40 on Sun, 27 Sep 2015 07:10:50 UTC
All use subject to JSTOR Terms and Conditions
 Rising Conservatism: Implications
for Financial Analysis
Dan Givolyand Carla Hayn
We provideevidencethat is consistentwith an increasein reporting
conservatism by U.S. companiesin thepastfewdecades.Usinga constant
sample of almost 900 companies,we examinedseveral measuresof
accountingconservatism, includingthelevelandrateofaccumulation over
time of negative nonoperatingaccruals,the differentialtimelinessof
incorporatinggood news versus bad news in reportedearnings, the
skewnessand variabilityof the earningsdistributionrelativeto the cash
flows distribution,andchangesin themarket-to-book ratio.Theincreased
conservatismhas contributedto a persistentand prevalentdeclinein
reported an increasein theincidenceoflosses,andan increase
profitability,
in thedispersionofearnings.Increasedconservatism ratios
affectsfinancial
and P/E multiples.Thus, incorporatinginformationon the level of a
company'sreportingconservatismimprovesvaluationsand the yield to
investmentstrategiesthatarebasedon theseratios.

I n assessing whether currentstock prices are
"correct," "undervalued," or "inflated," in-
vestors often rely on accounting-based
benchmarks, such as the P/E multiple or the
market-to-book ratio (market value of equity
divided by book value of equity, M/B). Other things
being equal, historically high P/Es and M/Bs indi-
cate to investors a potential "overpricing" of the
stock market. Indeed, the P/E seems to be a widely
accepted gauge for the appropriateness of market
valuations (for recent examples, see Campbell and
Shiller 1998 and VWhite2000).
To be sure, investors' reliance on P/Es or M/Bs
is not naive. They give due consideration to risk and
expected growth. Furthermore, they appear to take
into account the fact that in recent years, the consid-
erable investment in intangibles has depressed earn-
ings and book values, thus artificially inflating both
P/Es and M/Bs. Investors should be aware, how-
ever, of a potential trend toward more conservative
financial reporting. If such a trend exists, P/Es and
M/Bs may change without implying anything
about the fundamentals of the companies.
Conservatism is an important convention of
financial reporting. It implies the exercise of caution
Dan Givoly is professorof accountingat the University
of Californiaat Irvine and theformer chairmanof the
IsraelAccounting StandardsBoard.CarlaHayn is pro-
fessor ofaccountingat the Universityof Californiaat Los
Angeles.
in the recognition and measurement of income and
assets. Although no authoritative definition of con-
servatism exists, it generally suggests an early rec-
ognition of expenses and losses and a deferred
recognition of revenues and gains.1 In particular, a
conservative approach calls for the reporting of
losses and asset impairments once they can be rea-
sonably anticipated while gains are reported only
when they are realized.
There are some indications that a trend toward
increased conservatism has taken place since the
early 1980s. Many of the accounting pronounce-
ments in the past 20 years in the United States have
had the effect of advancing expense recognition,
and the adoption of these standards is often accom-
panied by a one-time catch-up charge. For example,
an earlier recognition of expenses characterizes all
of the new accounting standards dealing with
employee benefits and compensation.2 Also, more
conservative guidelines than those mandated by
earlier pronouncements were introduced by the
recent standards on the impairment of assets.3
These observations are consistent with the results
reported by Leftwich (1995), who found that most
of the Financial Accounting Standards Board
(FASB) agenda decisions4 between 1978 and 1995
concerned proposals that, if implemented, would
result in additional liabilities or delayed income
recognition. Moreover, the increasingly litigious
U.S. environment seems to have led auditors and
company managers to adopt more conservative

56 62002, AIMR?

This content downloaded from 141.216.78.40 on Sun, 27 Sep 2015 07:10:50 UTC
All use subject to JSTOR Terms and Conditions

reporting.Auditors have become more careful in
client selection and less willing to accommodate
management reporting objectives.5Managers,for
their part, show a greatertendency to warn inves-
torsaboutunfavorabledevelopmentsand to volun-
tarily release bad news (see, for example, Skinner
1994).They also tend to recognizeexpenses earlier.
For example, even though companies could have
amortizedthe adverseeffectsof adoptingSFASNo.
106,Employer's Accountingfor PostretirementBenefits
OtherThanPensions(1992),over future years, most
companies elected to reportthe full impact of this
statement in the year of its adoption. Similarly,
many companies chose to write down the part of
the purchase price attributable to research and
development expenditures (known as in-process
R&D)immediatelyratherthanamortizethese costs
over time.6The increasein the frequencyof write-
offs in recent years, which has attractedthe atten-
tion of both the U.S. SECand the FASB,mirrors,in
part, the more conservative reporting stance by
corporatemanagers.
To be sure, some evidence suggests that finan-
cial reporting,or at least the applicationof financial
reporting standards by company managers, has
becomelessconservative.Thisevidenceincludesthe
increased use by acquiring companies of the
pooling-of-interests method and the income-
increasingnatureof manyof the aggressiveaccount-
ing policies that have become the hallmarkof the
"new economy." These income-increasingreport-
ing patterns have prompted a number of new
accountingstandards(e.g., SFASNo. 141, Business
Combinations, 2001)and regulatoryactions(e.g.,SEC
StaffAccountingBulletinNo. 101,1999,on revenue
recognitionand its follow-ups,SABNos. lOlA and
10iB, 2000).7
The issue of whether accountingin the United
States has become more conservativeover time is
important for investors and regulatorybodies. A
more conservativereportingregime suggests that
a time-series analysis of financialstatements may
not be meaningful unless adjustmentis made for
the varyinglevels of conservatism.In fact,financial
analystsarealreadymakingthis type of adjustment
when comparing financial statements of compa-
nies in different countries (French and Poterba
1991;Gray 1980;Speidel and Bavishi 1992).
The issue of conservatismrelatesto the debate
about whether the high level of stock prices in the
past few years representeda "bubble."Those con-
tending that the U.S. stock markets were (until
recently)artificiallyinflated often supported their
claim by the historically high earnings multiples
and M/B values (see, for example, Cole, Helwege,
and Laster 1996, Dreman 1998, and Wyatt 1996).
January/February2002
This content downloaded from 141.216.78.40 on Sun, 27 Sep 2015 07:10:50 UTC
All use subject to JSTOR Terms and Conditions
Rising Conservatism
However, if financialreportingby U.S. companies
has indeed become more conservative, the time-
series comparisons of these valuation measures
may not be appropriate.
Despite the fact that the issue of conservatism
has attracted some attention from analysts,
accounting standard setters, and regulators, the
empiricalfindings regardingthe extent of-and, in
particular,the trend in-conservatism are scant.8
The study reportedhere is an empiricalexamina-
tion of the trend in the degree of conservatismin
financial reportingsince the 1950s and an assess-
ment of its effect on financialratios used for com-
pany valuation.
Measuring Reporting
Conservatism
The imperative of conservatism-to anticipateno
profits but anticipate all losses-suggests several
empiricalmeasures that can be used to gauge the
degree of, and changes in, accounting conserva-
tism. One is the sign and magnitude of accumu-
lated accrualsover time (Givoly and Hayn 2000).
Accruals, which are the difference between net
income and cash flows, tend to reverse:Periods in
which net income exceeds (falls below) cash flows
from operations are expected to be followed by
periods with negative (positive)accruals.Forcom-
panies in a steady state, the cumulativeamount of
net incomebeforedepreciationand amortizationis
expected to converge in the long run to cash flows
from operations. A consistent predominance of
negative accrualsfor companiesover a long period
is, all else being equal, an indication of conserva-
tism;the rateof accumulationof net negative accru-
als is an indication of the shift in the degree of
conservatismover time.
Anothermeasure of conservatismis based on
the observation that conservatisminduces asym-
metry in the timeliness of incorporatingeconomic
events in reportedearnings;"badnews" is reflected
in earnings more promptly than "good news." As
a result,earningsareexpectedto be morecorrelated
with stock price movements in periods character-
ized by bad news than in periods characterizedby
good news. The resultingmeasureof conservatism
is thus the excess of the association of stock price
movements with earnings in bad-news periods
over their associationwith earningsin good-news
periods (Ball,Kothari,and Robin 1999;Basu 1997;
Givoly and Hayn 2000;Holthausenand Watts2001;
Pope and Walker 1999). We used both of these
measures-the asymmetricalresponse of earnings
to good and bad news and the accumulation of
accruals-to gauge the change in reportingconser-
vatism over time.
57
FinancialAnalystsJournal
The notion that bad news is reported sooner
than good news in conservative reporting served
as the basis for yet another set of conservatism
measures. Note that if conservatism leads to an
immediate and complete recognition of negative
events and a delayed and gradual recognition of
positive events, it is likely to result in a negatively
skewed earnings distribution.Furthermore,to the
extent that increased conservatismtakes the form
of either a more immediate (ratherthan gradual)
recognition of bad news or a greater tendency to
provide for anticipatedfuture costs or losses, such
an increase will be associated with an increase in
variabilityof the earningsseries. Accordingly,two
additionalmeasuresof conservatismare the skew-
ness and the variabilityof the earningsdistribution.
A final proxy for conservatismis derived from
the fact that conservatismis ultimatelyreflectedin
the understatementof assets and overstatementof
liabilities. The M/B, which captures the market's
valuation of the net assets of the company relative
to the recordedbook values, provides an indication
of this relative under- or overstatement.A ratio
higher than 1 indicates conservative accounting,
and other things being equal, an increase in the
ratio over time suggests an increase in the degree
of reportingconservatism.9
To summarize,we used four sets of measures
in this study to estimatethe extent of, as well as the
shift in, reportingconservatismin the United States
over the past five decades:
* the level and rateof accumulationover time of
negative nonoperatingaccruals,
* measuresbased on the earnings-returnassoci-
ation during periods of good and bad news,
* the skewness and variability of the earnings
distributionrelativeto the cash flows distribu-
tion, and
* changes in the M/B.
Sample
The sample consists of all companieswith the nec-
essary data in the 1999 Compustat database con-
tained in the Primary,Secondaryand Tertiary,Full
Coverage,and Researchfiles. Theresultingsample,
referredto as the "full sample,"spans the 49-year
period from 1950 through 1998. Utilities were
excluded from the analysis because their earnings
are affectedby unique institutionaland regulatory
factors.The full sample increasedin size from 593
companies in 1950to about 9,000 in the late 1990s,
reflecting the addition of new companies to the
Compustat database. To ensure comparabilityof
the results over time, we conducted most of the
analyses on a constant sample of 896 companies
58
This content downloaded from 141.216.78.40 on Sun, 27 Sep 2015 07:10:50 UTC
All use subject to JSTOR Terms and Conditions
thatexisted for the entire1968-97period (hereafter,
"the constant sample").Returninformationcame
from the Center for Research in Security Prices
(CRSP)database.
Earnings, Cash Flows, and
Accruals
In this section,we provide descriptivestatisticson
the time-seriespatternsof earningsand cash flows
over the past 49 years. Although not directlybear-
ing on the issue of conservatism, these statistics
help in the interpretationof some of the findings
reportedlater.Toallow for cross-sectionalaggrega-
tion, we deflatedall of the flow variables(earnings,
cash flows) for each year by the total assets at the
beginning of that year.
Profitability.The pattern of company profit-
ability over the past five decades documented by
Givoly and Hayn (2000)is shown for both the full
and constantsamplesin Figure1. In linewith previ-
ous findings (see Collins,Maydew, and Weiss 1997
and Hayn 1995),the percentageof companiesin the
full sample that reportedlosses in this period (see
the bargraphsand scale on the rightaxis)increased
significantly-from 2-3 percentin the earlyyearsto
morethan35 percentin the late 1980sand 1990s.The
constantsample shows a similartrend.
This increasein the frequencyof losses reflects
the drop in reported profitabilityover the years
(shownby the graphlines and scale on the left axis).
For the full sample, the accountingrate of return,
defined as the ratioof net income to total assets (or
returnon assets,ROA),shows a continuousdecline
over the years.10It fell fairly steadily from a mean
of about 7 percentin the 1950sto -8 percentin the
1990s.11Someportionof this declineis undoubtedly
a result of the changingcompositionof companies
in the Compustat database, which expanded
through the addition of smaller, younger, and
potentiallyless profitablecompanies.Yet,a compa-
rable decline is evidenced for the constantsample:
a significantdrop in the averageROA fromalmost
8 percent in the 1950s to only 3 percent in the
1990s.12,13
We obtained similar results (not presented
here) when we used income from continuingoper-
ations, rather than net income, in computing the
ROA. This measure of earnings is devoid of the
effect that "below the line" items (discontinued
operations,extraordinaryitems,andthe cumulative
effect of changes in accounting principles) might
have on companies' profitability,which suggests
that the decline over time in profitabilitydid not
resultfrom these items.
?2002, AIMR?
 Rising Conservatism

Figure 1. Return on Assets and Frequency of Losses: Full and Constant

Samples, 1950-98
Return on Assets (%) Frequency of Losses (%)
15 60

10 - 50
.Mean ROA for Constant Sample
(left axis)
5 .*40

Mean ROA for Lull Sample

0 (left axis) 30

-5 -20

-10 - 10

-15 ___

50 53 56 59 62 65 68 71 74 77 80 83 86 89 93 95 98

Frequency of Losses by Year (right axis)

M Full Sample E Constant Sample

Source:Givoly and Hayn (2000).

g Company-sizeeffects.The similarity between
the results obtained for the full sample and those
for the constant sample suggests that the phenom-
ena of reduced profitability and increased earnings
dispersion may be equally strong for small and
large companies. To examine the role of company
size, we partitioned the constant sample of compa-
nies each year into five portfolios based on their
asset value at the beginning of the year and com-
puted the frequency of losses and statistics on ROA
for each portfolio in each year. Summary results are
reported in Table 1 by subperiod.
Note that, although the decline in profitability
and the increase in losses are more pronounced for
smaller companies, the patterns observed in the
earnings data hold for all the company-size portfo-
lios. The frequency of losses for the smallest com-
pany-size portfolio increased from an average of
7.2 percent in the first five-year period to 35.2 per-
cent in the most recent years. The mean ROA of that
portfolio dropped almost 15 percentage points
(pps) over the same period. The largest companies
show similar, although somewhat less dramatic,
trends.14
X Industryeffects.We provide the main results
by industry groups for two subperiods-1956
through 1975 and 1976 through 1998-in Table 2.
Panel A shows that the drop in profitability and the
increase in the number of losses reported are preva-
lent for most of the 272 industry groups. The average
percentage of losses in these industries increased
more than 10 pps between the two subperiods, and
the mean ROA for the industries in the second sub-
period was about half of what it averaged in the first
period. As Panel B shows, we obtained similar
results when, instead of decomposing the sample by
SIC codes, we partitioned the companies by "high-
technology" and "low-technology" industries.15
The fact that the patterns of reduced profitability
and increased incidence of losses occurred in a wide
range of industries and company groups suggests
that these trends cannot be attributed to the chang-
ing industry composition of our sample.
The profound changes in the distributional
properties of earnings that all companies in the
sample, regardless of size and industry, appear to
have experienced raise the question of whether the
changes reflect the underlying performance of the
corporate sector or are the result of changes in the
reporting rules and environment. Has the "map-
ping" between companies' economic condition and
their accounting reports changed over time? This
question is important for investors, regulators,
accounting standard setters, and researchers. But
despite its importance, these persistent changes in
the reported results of publicly traded companies
have not, to the best of our knowledge, drawn
much attention from the financial community.

January/February 2002 59

This content downloaded from 141.216.78.40 on Sun, 27 Sep 2015 07:10:50 UTC
All use subject to JSTOR Terms and Conditions
FinancialAnalystsJournal

Table 1. Frequency of Losses and ROAby Contributors to Reduced Profitability. We

Company Size: Constant Sample, attempted to identify the causes of the drop in
1956-98 by Subperiod reportedearningsthroughfundamentalanalysisby
decomposingROAinto four auxiliaryratios-sales
Frequency of ROA
Median
to total assets, net income to sales, net income to
Period Losses Mean
equity,and assets to equity.As reportedin Table 3,
Portfolio1. Smallest:mean asset value $41.1 million
the results show that the decline in ROA can be
1956-60 7.2% 0.077 0.079
attributedto both a decline in the asset tumover
1961-65 8.5 0.073 0.074
ratio and a decreasein returnon sales. Despite an
1966-70 9.0 0.071 0.072
increase of about 50 percent in financial leverage
1971-75 14.2 0.043 0.053
(measuredby assets to equity) over the period, net
1976-80 12.4 0.058 0.065
incometo equityactuallydecreasedfrommorethan
1981-85 23.2 0.030 0.048
13 percentin the earlyyears of the sampleperiod to
1986-90 29.1 0.007 0.033
35.2 0.031
about 9 percentin recentyears.
1991-98 -0.071
To further examine the source of the decline
Portfolio2. Mean asset value $156.0 million in reportedearnings, we analyzed the behavior of
1956-60 1.7 0.079 0.074 individual components of the income statement.
1961-65 6.5 0.074 0.073 Table 4 shows a representativeincome statement
1966-70 5.6 0.072 0.070 expressed in terms of the sample mean ratio of
1971-75 7.9 0.059 0.058 various line items to sales for three subperiods.
1976-80 7.1 0.066 0.068 The results in the rightmost column indicate the
1981-85 12.8 0.054 0.058 impact of the change (positive or negative) over
1986-90 16.5 0.034 0.049 time in each line item on the ratio of net income to
1991-98 22.4 0.033 0.041 sales. The drop in this ratio from the earliest sub-
Portfolio3. Mean asset value $415.6 million period to the latest one is more than 4 pps (from
1956-60 2.6 0.076 0.066 5.9 percentin 1956-70to 1.7 percentin 1981-1998).
1961-65 2.4 0.071 0.065 This decline can be attributed primarily to an
1966-70 3.6 0.069 0.064 increase in three expense items-selling, general,
1971-75 6.4 0.064 0.059 and administrative expenses (SG&A), interest
1976-80 5.6 0.075 0.073 expenses, and special items.
1981-85 11.4 0.055 0.060 On average,SG&Aas a percentageof sales rose
1986-90 18.6 0.043 0.053 from the earliestsubperiodto the latest subperiod.
1991-98 21.8 0.032 0.043 Theincreasein the ratioof SG&Ato sales is impres-
sive consideringthe fact that the entireperiod was
Portfolio4. Mean asset value $1,271.4 million
characterizedby a continuousgrowth in sales and
1956-60 1.1 0.075 0.068
thata portionof SG&Ais fixed.' Thisincreasein the
1961-65 1.8 0.072 0.064
prominenceof SG&Ain companies'cost structures
1966-70 2.7 0.068 0.063
has not gone unnoticedby managersand research-
1971-75 3.8 0.060 0.055
ers who, in the contextof managementaccounting,
1976-80 2.5 0.073 0.073
have noted that these expenses should be consid-
1981-85 11.9 0.048 0.054
ered in productcosting and pricing (see, for exam-
1986-90 12.4 0.048 0.054
ple, Miller and Vollman 1985). The fact that the
1991-98 18.1 0.037 0.042
increasedweight of these costs is so materialas to
Portfolio5. Largest:mean asset value $9,591.0 million dampenprofitabilityin a very steady and prevalent
1956-60 1.2 0.066 0.063 patternhas not, however,been fully recognized.
1961-65 0.8 0.064 0.061 Anothercontributorto the dropin the returnon
1966-70 2.0 0.057 0.053 sales is interestexpense, which almost tripledrela-
1971-75 3.1 0.056 0.052 tive to sales from the early subperiod to the last
1976-80 2.4 0.063 0.062 subperiod;this increaseis a direct consequenceof
1981-85 9.1 0.049 0.051 increasedfinancialleverage.Theleverageeffectcan-
1986-90 9.1 0.048 0.049 not explain the drop in ROA, however, because a
1991-98 16.9 0.037 0.035 considerable portion of the decline over time is
Note: The most extreme 0.5 percent of the cases at either end of already registered in the ratio of earnings before
the distribution each year were truncated. interestand taxes (EBIT)to total assets.

60 ?2002, AIMR?

This content downloaded from 141.216.78.40 on Sun, 27 Sep 2015 07:10:50 UTC
All use subject to JSTOR Terms and Conditions
 Rising Conservatism

Table 2. Frequency of Losses and ROAby Industry Group: Constant

Sample, 1956-98 by Subperiod
Industrieswith 10% Industrieswith a
AverageLosses or Moreof Companies MeanIndustry Drop in MeanROA
Period within Industry Experiencinga Loss ROA between Subperiods
A. Industriesbasedonfour-digitSICCode(n = 272)
1956-75 5.2% 19.5% 0.065 67.3%
1976-98 15.9 62.5 0.036
B. High-techindustries(n = 46)
1956-75 7.7 23.9 0.022 69.4
1976-98 19.8 76.1 -0.013
C.Low-techindustries(n = 102)
1956-75 4.6 13.3 0.058 64.0
1976-98 17.6 59.2 0.031
Note:The ratioof mean industrynet incometo total assets is the simple averageof this ratioover all
company-yearswithin the industry.

Thelast importantcontributorto the declinein
profitabilityis the specialitems. These items repre-
sent mostly the effect of restructuring,write-offs,
and write-downs that became more prevalent in
the laterperiod (see Collins et al., Elliottand Shaw
1988,and Givoly and Hayn 1994).
As expected, the decline in pretaxprofitability
cut the ratio of income tax expense to sales almost
in half from the first to the last periods. Yet, Panel
B of Table4 shows that the effective tax rate itself
decreased only slightly in the later years, despite
the considerablereduction in the corporatestatu-
tory tax rate arising from the Tax Reform Act of
1986.A possible reasonfor the slight decreaseis the
prevalenceof losses in the laterperiod.17
Othercontributorsto the declinein profitability
were an increase in depreciationexpense and in
below-the-lineexpenses (i.e.,losses from extraordi-
naryitems,discontinuedoperations,and the cumu-
lative effect of accountingchanges). The increases
in SG&Aand special items (which jointly resulted
in a drop in the net income-to-salesratioof 3.8 pps
between the first and last subperiods)might have
been causedby economicfactors,but these expense
items,which includerestructuringchargesor write-
offs, are also sensitive to accountingchoices.
Cash Flows and Accruals. An intriguing
questionregardingthe increasein the frequencyof
losses and the deteriorationin reportedearningsis
whetherthese changesreflecta realdrop in the eco-
nomicperformanceof the companiesor areaccount-
ing driven.To investigatethis issue, we turnedto a
measureof companyperformancethatis unaffected
by accrual accounting, namely, cash flows from
operations. Cash flows from operations (CFO)is
definedas the cashreceivedfromcustomersless the
cashpaid to providersof input (labor,suppliers),to
creditors(interest),and to tax authorities.
We used the ratio of CFOto assets (CFOA)to
assess companies' real economic performance.18
We found that changes in CFOA over the period
reflectedno particulartrendover time;the average
in most subperiodswas about9 percent.In contrast

Table 3. Decomposition of ROA:Constant Sample, 1956-98 by Subperiod

Net Income to Sales to Net Income to Net Income to Assets to
Assets Assets Sales Equity Equity
Period Mean Median Mean Median Mean Median Mean Median Mean Median
1956-60 0.074 0.069 1.539 1.345 0.063 0.054 0.133 0.123 1.982 1.982
1961-65 0.071 0.066 1.555 1.381 0.065 0.051 0.131 0.122 2.111 1.701
1966-70 0.068 0.062 1.499 1.337 0.065 0.049 0.117 0.121 2.148 1.831
1971-75 0.056 0.055 1.493 1.327 0.050 0.043 0.104 0.114 2.262 1.948
1976-80 0.066 0.068 1.602 1.430 0.057 0.048 0.122 0.142 2.332 2.008
1981-85 0.047 0.054 1.469 1.320 0.039 0.041 0.076 0.121 2.485 2.064
1986-90 0.036 0.049 1.322 1.212 0.015 0.040 0.066 0.118 2.939 2.230
1991-98 0.012 0.039 1.325 1.198 -0.015 0.032 0.089 0.100 2.964 2.352

January/February 2002 61

This content downloaded from 141.216.78.40 on Sun, 27 Sep 2015 07:10:50 UTC
All use subject to JSTOR Terms and Conditions
FinancialAnalysts Journal

Table 4. Representative Income Statement and Financial Ratios, 1956-98 by

Subperiod
Impact of Change
1956-70 1971-80 1981-98 in Line Itemsa
Measure (n = 7,472) (n = 7,276) (n = 11,462) (pps)
A. Incomestatement
Sales 100.0% 100.0% 100.0%
- Cost of goods sold 68.4 69.7 68.8 -0.4
Gross profit 31.6% 30.3% 31.2%
- SG&A expense 16.8 17.2 19.9 -3.1
- Depreciation 4.1 3.4% 4.6% -0.5
Income before interest expense 10.7% 9.7% 6.7%
- Interest expense 1.3 2.0 3.2 -1.9
- Special items 0.0 0.0 0.7 -0.7
+ Nonoperating income (loss) 1.1 1.5 1.7 +0.6
Pretax income 10.5% 8.9% 4.5%
- Income tax expense 4.7 3.9 2.4 +2.3
Income from continuing operations 5.8% 5.0% 2.1% -3.7
+ Discontinued operations,
extraordinary items, cumulative
effect of accounting changes 0.1 0.0 -0.4 -0.5
Net income 5.9% 5.0% 1.7% -4.2

B. Rates and ratios

Sales/assets 1.56 1.60 1.43
Tax rateb 43.3% 42.8% 39.0%
ROA 7.0% 6.1% 3.0%
Note: The most extreme 0.5 percent of the cases for each ratio each year were truncated. For any given
year, only companies with complete data for all items were considered.
aImpact of change between earliest and latest subperiods on the ratio of net income to sales.
bThe tax rate was calculated as the tax expense divided by pretax income (except that when the tax
expense was positive and pretax income was negative, it was set equal to 1.0). This ratio was truncated
at +/-1.0.

to earnings, we found no increase in the incidence
of negative cash flows, nor did we find a decrease
in the CFO-to-assets ratio over the 49-year period.19
These results strongly suggest that the decline
in profitability is not a result of a change in the
distribution of the underlying cash flows but, rather,
results from a change in the relationshipbetween cash
flows and earnings-that is, a change in accounting
accruals. This relationship is explored in the next
section.
0 Accumulationof accruals.In a steady state,
one would expect the cumulative amount of net
income (before depreciation and amortization) to
converge in the long run to cash flows from oper-
ations. Figure 2 provides evidence of the actual
reversal of accruals for our constant sample of
companies. For each of the years 1966 to 1998, we
plotted the difference between cumulative net
income before depreciation and amortization
(hereafter referred to collectively as "deprecia-
tion") and the cumulative cash flows from opera-
tions, up to that year, aggregated over the constant
sample, as shown in the line labeled "Cumulative
Total Accruals (before depreciation)."20
An important finding that emerges from the
figure is that accruals (excluding depreciation)
across the sample companies do not cancel out (i.e.,
do not sum to zero) over time. Instead, two distinct
subperiods emerge, from the mid-1960s to the early
1980s and from the early 1980s to 1998. In the earlier
subperiod, the aggregate cumulative net income
(adjusted for depreciation) slightly exceeds the
aggregate cumulative cash flows from operations.
In other words, excluding depreciation, the sample
companies generated net positive accruals up until
about 1981, when accruals began to be slightly
negative. In contrast, the second subperiod shows
an almost continuous accumulation of negative
accruals. That is, net income before depreciation in
the later subperiod was systematically and consis-
tently below cash flows from operations. The mag-
nitude of the signed accumulation of total accruals
(before depreciation) is not trivial. For the constant
sample, this accumulation over the years 1966-1998

62 ?2002, AIMR_

This content downloaded from 141.216.78.40 on Sun, 27 Sep 2015 07:10:50 UTC
All use subject to JSTOR Terms and Conditions
 Rising Conservatism

Figure 2. Cumulative Accruals by Type: Constant Sample, 1966-98

$ Billions
1,500

1,000 _

500 -

-500

-1,000

-1,500

-2,000 l l l l l l l l l l l l l l
6566 68 70 72 74 76 78 80 82 84 86 88 90 92 94 96 98

Cumulative Operating Accruals

.* Cumulative Total Accruals
(before depreciation)
Cumulative Nonoperating Accruals without
Special Items and Discontinued Operations
- - - Cumulative Nonoperating Accruals
Notes: Total accruals (before depreciation) = (Net income + Depreciation) - Cash flows from operations.
Operating accruals = AAccounts receivable + Alnventories + APrepaid expenses - AAccounts
payable - AAccrued expenses - ATaxes payable.
Nonoperating accruals = Total accruals (before depreciation) - Operating accruals.

amounts to almost -$400 billion, which represents
more than 16 percent of the cumulative net income
of the sample companies for the same period.
Accrual components. The lines labeled
"Cumulative Operating Accruals" and "Cumula-
tive Nonoperating Accruals" of Figure 2 provide
further insight into the nature of the accrual accu-
mulation. These lines depict the behavior over
time of components of total accruals (other than
depreciation), specifically operating (or "working
capital") accruals and nonoperating accruals.
Operating accruals arise from the basic day-to-day
operations of the business and are defined as the
change in current asset accounts (accounts receiv-
able, inventory, and prepaid expenses) minus the
change in those current liability accounts arising
from operations (accounts payable, accrued
expenses, and taxes payable).
Whereas the total accruals (excluding depreci-
ation) exhibit a negative accumulation over time in
Figure 1, operating accruals show a markedly dif-
ferent pattern. Consistent with the growth of the
sample companies, operating accruals increased to
a total aggregate accumulation of almost $1,500
billion for the constant sample by the end of 1998.
The pace of accumulation of the operating accruals
was relatively slow in the early years but acceler-
ated from the late 1970s onward.
Extracting depreciation, amortization, and the
operating accrual components from total accruals
results in accruals consisting primarily of such
items as losses and bad debt provisions (or their
reversal), restructuring charges, the effect of
changes in estimates, gains or losses on the sale of
assets, asset write-downs, the accrual and capitali-
zation of expenses, and the deferral of revenues and
their subsequent recognition. These remaining,
"nonoperating" accruals, although dictated to
some extent by generally accepted accounting prin-
ciples (GAAP), are largely discretionary in nature,

January/February 2002 63

This content downloaded from 141.216.78.40 on Sun, 27 Sep 2015 07:10:50 UTC
All use subject to JSTOR Terms and Conditions
Financial Analysts Journal
with the timing and/or amount of most of them
subject to management discretion. The accumula-
tion of these nonoperating accruals over time, our
first measure of conservatism, is illustrated by the
line labeled "Cumulative Nonoperating Accruals"
in Figure 2. Note the fairly steady accumulation of
negative nonoperating accruals over the period
examined. The net negative accumulation is most
pronounced in the more recent years, and the total
accumulation of these accruals is substantial-2.8
percent of the cumulative sales of the sample com-
panies for that period and 32.2 percent of their total
assets as of the end of 1998.
The accumulation of negative accruals shown
in Figure 2 in the second half of the period was
common to most companies and industries. The
average annual accumulation of accruals per com-
pany in the second half of the period was signifi-
cantly more negative than in the early half of the
period. Furthermore, the negative accumulation of
nonoperating accruals in the second subperiod
occurred in 264 of the 272 four-digit industries. The
ratio between this accumulation in the second sub-
period and that in the first subperiod is 6.1 for the
constant sample, with an interquartile range for the
272 industries between 2.9 and 7.7.
The finding of a prevalent and significant accu-
mulation of negative nonoperating accruals is con-
sistent with an increase in reporting conservatism
since the early 1980s.
11 Alternativeexplanations.The decline in prof-
itability and the increased accumulation of negative
accruals could have several explanations other than
conservatism. Both phenomena could be a reflec-
tion of real economic developments rather than
reporting patterns, or they could be merely artifacts
of our measurement procedures. Following is a
brief account of our tests of some alternative expla-
nations.
* Restructuring. In the past two decades, many
companies have restructured their operations.
This real activity naturally triggered noncash
charges to income but without implying greater
reporting conservatism. To examine the extent
to which restructuring explains the results, we
recomputed the nonoperating accruals exclud-
ing two components that are most likely to
capture the effect of restructuring activities-
special items and gains or losses from discon-
tinued operations. The results, presented in the
line labeled "Cumulative Nonoperating Accru-
als without Special Items and Discontinued
Operations" in Figure 2, show that these com-
ponents did indeed dampen reported earnings,
but the extensive accumulation of negative
accruals persisted even after their exclusion.
64
This content downloaded from 141.216.78.40 on Sun, 27 Sep 2015 07:10:50 UTC
All use subject to JSTOR Terms and Conditions
Note that the restructuring explanation is also
inconsistent with the finding presented earlier
that the drop in profitability was prevalent for
almost all industries; that is, it affected not only
those in which restructuring was common
(most notably, the manufacturing sector) but
also industries (such as those in the high-tech
group) that were less affected by this trend.
Mergersandacquisitions.Another possible expla-
nation for the drop in corporate profitability is
the accounting effects arising from the recurring
waves of mergers and acquisitions during the
five decades spanned by our investigation.
Most of the acquisitions in the past two decades
were accounted for by the purchase method,
which tends to dampen profitability (and
increase negative accruals) because of the
added depreciation and amortization arising
from the revaluation of acquired tangible assets
and the amortization of goodwill. Furthermore,
because many acquisitions were financed with
debt, subsequent profits were adversely
affected by the increased financial charges. To
test the plausibility of the M&A explanation, we
first examined the trend in EBITDA (earnings
before interest, taxes, depreciation, and amorti-
zation). The results (not shown) reveal a pattern
of decline similar to that observed for the other
measures of profitability-ROA and EBIT to
assets. Second, we formed for each year a port-
folio of all companies that did not engage in an
acquisition in any of the preceding five years.
We then replicated Figure 1 for this subsample
of companies whose earnings were unlikely to
be affected by acquisitions. We found the
decline in ROA over the years for this subsam-
ple to be statistically indistinguishable from the
results for the full sample. Finally, we repro-
duced the accrual accumulations of Figure 2
excluding companies that engaged in M&A
activity during the period. These results (not
shown) also were similar to the results for the
entire sample.
* Growthand inflation.A potential technical expla-
nation for the observed accumulation of nega-
tive accruals is the growth of the sample
companies. Growth, whether real or nominal
(resulting from inflation), produces an increase
in the size of earnings and cash flows and, con-
sequently, of accruals. We controlled for growth
in the initial tests by deflating the accruals by
total assets, but the deflator may not have fully
captured the scale of operations that gave rise
to the accruals. Therefore, a reappraisal of the
growth explanation is in order. The full sample
of companies indeed exhibited impressive
?2002 1AIMR?

growth throughout the examined period, but
the growth explanation is not supported by
furtheranalyses for several reasons. First,the
companiesgrew throughout the entireperiod.In
fact, the average geometricannual growth rate
in sales was even higherin the earlypart of the
period (13.5percentfor 1950-1980)than in the
more recent years (6.9 percent for 1981-1998).
Second, when we used sales or the change in
sales,ratherthantotalassets,to deflatethe accu-
mulation,the resultsremainedintact.Inflation
is also unlikelyto have causedthe accumulation
of negative accruals.No discernibleaccumula-
tion of negative accrualsoccurredin the 1960s
or the 1970s,yet the mean annualinflationrate
in those years (4.9percent)was higherthanthat
(4.1 percent)in the period in which the major
accumulationoccurred.
In summary,the evidence is inconsistentwith
several altemative explanationsfor the decline in
reportedprofitabilityand the increasein accumula-
tion of negativeaccrualssincethe early1980s,which
increasesthe likelihoodthat a rise in reportingcon-
servatismis the explanationfor these phenomena.
The Return-Earnings Association. Another
set of measures that we used to assess reporting
conservatismis the differenceovertime in the speed
at which eamings reflect economic events. We
hypothesized that if accountinghas become more
conservative,the response to bad news will have
become more timely than the response to good
news. To examinethis hypothesis,we estimatedthe
"earningsresponse" coefficient from a regression
estimatedfrom all company-years.Specifically,we
regressedEPS(deflatedby price)on the contempo-
raneousreturnand a dummy variablewhose coef-
ficient estimated the differential response of
earningsto bad news and good news. We identified
periodsof bad (good)news as those with a negative
(positive) return.The regressionand the variables
aredescribedin AppendixA. Theregressionresults
produced a number of measures for gauging the
incrementalearningsresponseto bad news relative
to good news as well as allowing us to measurethe
average downward bias in the earnings-to-price
ratio (E/P) because of conservatism.
Table 5 shows the averageannualvalues of the
measures produced by the regression.The results
indicate that financialreportingis in general con-
servative,in thatit defersrecognitionof good news
and acceleratesthe recognitionof bad news. More
importantly,a considerableand significantincrease
has occurredover time in the degree of conserva-
tism as capturedby these measures.
January/February 2002
This content downloaded from 141.216.78.40 on Sun, 27 Sep 2015 07:10:50 UTC
All use subject to JSTOR Terms and Conditions
Rising Conservatism
The first measure,the incrementalresponse to
bad news relativeto good news, ,1, is positive and
significant. Furthermore,P, increased markedly
over time. The hypothesis that the value of the
annual fr1is the same in the later years as in the
earlieryears is rejectedat the 1 percentsignificance
level. These results suggest that, consistent with
accounting conservatism, earnings reflect bad
news more promptly than good news. Moreover,
consistent with increasedconservatism in recent
years, the differentialresponse time to bad news
relative to good news has become more pro-
nounced in recentyears.
A similar pattern is exhibited by the second
measure,(Po+ f1))/1o, which assesses the sensitiv-
ity of earnings to bad news relative to their sensi-
tivity to good news (see Appendix A). Under
neutral (neither conservative nor aggressive)
reporting,this ratio should be 1. In Table 5, how-
ever, this ratio is always above 1, indicating a
greaterpropensityto recognizebad news in a more
timely manner than good news. Note that the
"overrecognition"of bad news is morepronounced
in lateryearsthanin earlyyears.Theratioincreases
almost monotonically to above 25 in the more
recentyears.
In a similarvein, the explanatorypower of the
regression (its R2) is larger when the regression
was estimated during negative-return(bad-news)
periods than during positive-returnperiods. Fur-
thermore,the ratio of the R2 in bad-news periods
to the R2 in good-news periods increased consid-
erably over the 49-yearperiod.
The "totalbias" measure,which expresses the
net downward effect on earningsof the overrecog-
nition of bad news and the underrecognitionof
good news as a fraction of true earnings (see
Appendix A), is shown in the last column of Table
5. Given that the average E/P across companies
and years in our sample was 0.09, the downward
bias in the E/P average for the full period of 0.011
suggests an average understatementof about 12
percent in earnings (0.011/0.09). This bias also
increased over time. In the earliest subperiod, the
bias was only about 2 percent of earnings, but it
increasedfairlysteadilyto about30 percentof earn-
ings in the latest subperiod.These bias results are
in line with the findings regardingthe accumula-
tion of negative accruals.
In summary, all the regression measures
designedto capturevariousaspectsof the timeliness
with which bad news is reportedrelative to good
news consistentlypoint to an increasein reporting
conservatismover time.
65
FinancialAnalystsJournal

Table 5. DifferentialReturn-Earnings Association in Good-News and Bad-News Periods: Constant

Sample, 1951-98 by Subperiod
(t-values in parentheses)
ExplanatoryPower of
IncrementalResponseof Sensitivityof Earningsto the Regressionin Periods TotalBiasin
Earningsto BadNews BadNews Relativeto Their of BadNews Relativeto Earningsa
Numberof Relativeto Good News Sensitivityto Good News Periodsof Good News (deflatedby
Period Observations (A)a [(&?+ l)/o]a (R2Bad/R2Good)a lagged price)
Overall
period 23,612 0.133 3.77 3.92 0.011
(15.05)
1951-55 544 0.019 1.73 0.71 0.002
(1.85)
1956-60 612 0.057 2.68 1.61 0.010
(2.24)
1961-65 1,080 0.074 4.22 1.95 0.011
(3.65)
1966-70 1,978 0.085 4.28 2.22 0.013
(5.86)
1971-75 2,930 0.199 4.83 2.89 0.012
(6.28)
1976-80 3,616 0.292 7.79 2.73 0.025
(8.90)
1981-85 3,658 0.346 18.30 8.10 0.023
(7.19)
1986-90 3,705 0.449 18.96 18.25 0.026
(12.02)
1991-98 5,481 0.521 25.81 22.17 0.031
(12.87)
aUnderneutralreporting,I, and totalbias (deflatedby lagged price)are expectedto be 0 and the ratios(f0 + pl)/Po and R2Bad/R2Good
are expectedto equal to 1. See AppendixA for regressionspecificationand definitions.

Skewness of Earnings. A basic feature of a examined. Moreover, it has become increasingly

conservativereportingsystem is the early and full
recognition of unfavorableevents in the financial
statements and the delayed and gradual recogni-
tion of favorableevents. If such propensitiesexist,
the earningsdistributionwill be negativelyskewed.
Figure 3 depicts the change in the skewness of the
ROAdistributionrelativeto thatof cashflows from
operationsovertime.Again,we used the cashflows
measure as a benchmarkfor assessing changes in
the earningsdistribution.The skewness measurein
each analysis is defined as
E(x-g3)
Y= 3 an increasein conservatism.
where x is ROA (or CFOA)and g and a are esti-
mated by the mean and standarddeviation of the
ROA (or CFOA)distribution.
Figure3 shows the skewness measurederived
from the cross-sectionof company-yearsand from
the time series of individual companies. Both sets
of resultsindicatethatthe earningsdistributionwas
indeed negatively skewed in most of the periods
negativelyskewed,whereasthe distributionof cash
flows from operationshas shown little movement
over time. The trend in the earningsdistributionis
monotonic,with the increasein skewness occurring
in the mid- to late 1970s and acceleratingin the
1980s. The distributions of other earnings mea-
sures, including those based on income from con-
tinuing operations and on income before special
items (not reported),reveal a similar pattern.The
negative skewness of the earnings distributionis
consistent with conservative reporting, and the
increasein the negative skewness is consistentwith
Variability of Earnings. Results for our next
measure of conservatism, the variability of the
earnings distributionover time, are in Table 6 in
the formof standarddeviationsby subperiodof net
income to total assets and of cash flows from oper-
ations to total assets. As can be seen, earningshave
become increasinglydispersed;the standarddevi-
ation of ROA rose from an average of about 0.060

66 ?2002, AIMRO

This content downloaded from 141.216.78.40 on Sun, 27 Sep 2015 07:10:50 UTC
All use subject to JSTOR Terms and Conditions
 Rising Conservatism

Figure 3. Time-Series and Cross-Sectional Skewness of Earnings and Cash

Flows: Constant Sample, 1956-98
SkewnessMeasure
1.0

0.5

-0.5 __

-1.0

-1.5

-2.0

-2.5l llllll
56 60 65 70 75 80 85 90 95 98
Net Income(crosssectional)
.*----- Net Income(time series)
- - - Cash Flow from Operations (cross sectional)
CashFlow fromOperations(time series)
Notes:All variableswere deflatedby totalassets.Valuesfor eachyear arethe five-yearmoving average
of the skewness measure,centeredon that year. The cross-sectionalvalue for each year is the average
value of the skewness measurecomputedacrossthe sample companies.The time-seriesvalue shown
for each year is the averagesample value of the skewness measurecomputedfor each company.The
skewness measurefor each company in any given year was based on the time series consistingof 11
annualobservationscenteredon thatyear.

Table 6. Standard Deviation of ROAand CFOA, individual companies.The mean ratio of the stan-
1951-98 by Subperiod dard deviation of ROA during the last subperiod
StandardDeviation (1981-1998)to the standarddeviation of ROAdur-
of ROA StandardDeviation ing the earlysubperiod(1951-1980)for the constant
Full Constant of CFOA: sample of companieswas 3.07, significantly(at the
Subperiod Sample Sample ConstantSample 1 percent level) above 1.0. Furthermore,about 75
1951-55 0.043 0.039 0.084 percent of the companies experiencedan increase
1956-60 0.052 0.044 0.073 in the standard deviation of their ROA measure
1961-65 0.060 0.051 0.085 between these two subperiods.
1966-70 0.081 0.058 0.088 We also found (not reported)that the increase
1971-75 0.119 0.065 0.084 in the dispersionof earningsdistributionwas com-
1976-80 0.165 0.090 0.083 mon to all company-size groups and industries.
1981-85 0.337 0.145 0.092 The standarddeviation of ROA of the portfolio of
1986-90 0.437 0.198 0.093 the smallest companies grew from 0.085 to 0.732
1991-98 0.517 0.287 0.086
between the 1951-80 subperiod and the 1981-98
Note:The most extreme0.5 percentof the cases at eitherend of subperiod. The largest companies experienced a
the distributioneach year were truncated.
less dramatictrend, but the standarddeviation of
theirROAstill doubled over this period,from0.033
in the years prior to 1971to an averageof 0.517for to 0.067.The mean annualcross-sectionalstandard
the full sample and 0.287for the constantsample in deviation of ROA of the 272 industries increased
the 1990s.21 from 0.046 in the early subperiod to 0.075 in the
We obtaineda similarresult (not shown) when later subperiod, with 78 percent of the industries
we analyzed the time series of earnings of showing an increased dispersion in ROA. We

January/February 2002 67

This content downloaded from 141.216.78.40 on Sun, 27 Sep 2015 07:10:50 UTC
All use subject to JSTOR Terms and Conditions
FinancialAnalystsJournal

obtained similar results when we partitioned the
companies into high-tech and low-tech groups.
In contrast to the ROA pattern of increased
earnings dispersion over time, the last column of
Table6 shows thatthe standarddeviation of CFOA
remained fairly stable, hovering around 0.08
throughout the examined period. This stability
was evident also in all company size groups and
industries.
To identify the contributorsto the increased
earnings variabilityand to relate variabilityto the
behavior of accounting accruals,we decomposed
the varianceof ROAinto its components:the vari-
ance of cash flows from operations,the varianceof
operatingand nonoperatingaccruals,and the cova-
riances between these variables. The results (not
reported)reveal that varianceof the nonoperating
accruals has been the greatest contributorto the
increase in earnings variabilityin recent decades.
Specifically,the greaterearnings and accrualvari-
ability is primarilya result of the rising incidence
of one-time large nonoperatingaccruals(as docu-
mented by Collins et al., Elliott and Shaw, and
Givoly and Hayn 1994).
Market-to-BookRatio. Our final measure of
the degree of reportingconservatisminvolved the
relationship between the market value and the
book value of companies'equity. To the extentthat
equity valuation by investors is based on the
presentvalue of futurecashflows, the M/B (aswell
as P/E multiples) should be higher when account-
ing measurementis more conservative.
Figure4 shows the trendin the aggregateM/B
(thesolid line)forthe constantsamplein the 1962-98
period.22The resultis a U-shapedcurvethatrose to
about 2.5 in the early 1960s, declined through the
early 1970sto reach a level of slightly above 1.0 in
the late 1970s,had risen again to 2.0 by the end of
the 1980s,and increasedsharplyto above 3.0 in the
1990s. These findings support the hypothesized
increasein conservatism.
To obtain further evidence of the extent to
which the increase in M/Bs in the second
subperiodis relatedto reportingconservatism,we
recalculated the ratios using as the denominator
an estimate of the book values that wouldhavebeen
reportedhad there been no accumulation of
negative nonoperating accruals. This adjusted
book value was computed as the reported book
value plus the accumulated nonoperating accru-
als as of the end of the period. We calculated
adjusted M/B values based on these adjusted
book values and plotted them as shown in Figure
4. In contrast to M/B, the adjusted M/B changed
little from the mid-1970s through 1998.23

Figure 4. Market-to-Book Ratio over Time: Constant Sample, 1962-98

Ratio
4.0

3.5

3.0

2.5
M/B

2.0

1.5

1.0 .~. .. *. .**..... ..* .* . . .. .. Adjusted

M/B

0.5-

0 l l l l l l l
62 64 66 68 70 72 74 76 78 80 82 84 86 88 90 92 94 96 98
Notes:The M/B is computedas the aggregatemarketvalue of the sample companiesdivided by their
aggregatebookvalue atyearend. TheadjustedM/B reflectsthe addingbackof cumulativenonoperating
accrualsto the book value.

68 ?2002, AIMR?

This content downloaded from 141.216.78.40 on Sun, 27 Sep 2015 07:10:50 UTC
All use subject to JSTOR Terms and Conditions
 Rising Conservatism

Note, however, that rather than reflecting a value adjustedfor cumulativenonoperatingaccru-

changein the degree of reportingconservatism,the
observed variation in the M/B over time might
reflectchangesin marketexpectationsof companies'
growth. Therefore,to control for growth expecta-
tions, we ranked all company-yearsby expected
growthratesand measuredthe medianM/B in each
portfolioforeachof two subperiodsshown in Figure
4, 1968-1980and 1981-1998.To constructthe port-
folios,we used two proxiesforexpectedgrowth:the
actualannual geometricgrowth rate in sales of the
company over the succeeding five years (the "for-
ward-looking approach")and the actual annual
geometricgrowth rate in the preceding five years
(the "backward-lookingapproach").24
Table 7 shows the expected growth rates,
median M/Bs, and median adjustedM/Bs for the
five portfolios ranked by expected growth in the
two subperiods,where expectedgrowth rateswere
estimatedusing the backward-lookingapproach.25
As reported in the first row, whereas the median
level of expected growth for the entire sample of
companieswas lower in the second subperiodthan
in the first subperiod, the median M/B for the
sample was much higher in the second subperiod.
The rows for the individual expected-growthport-
folios indicate,however, that the M/B within each
subperiod increased with expected growth. More
relevantto ourexaminationis thatthe M/B foreach
growth portfolio was greaterin the second subpe-
riod than in the first subperiod. Except for the
highest-growthportfolio,all differencesare statis-
tically significantat the 1 percentlevel.
Table 7 also reports our findings when we
replicatedthese results for the M/B with the book
als. After controlling for growth, we found the
median adjustedM/Bs of the entire sample and of
four of the five expected-growthportfolios to be
only slightly higher (butnot significantlyso) in the
second subperiod than the median adjustedM/Bs
in the earlier subperiod. Thus, the higher M/Bs
observedin recentyears appearto be partlydriven
by depressed book values arising from more con-
servative accounting.
The examinationbased on the adjustedM/Bs
may overstatethe contributionof increasedreport-
ing conservatismto the increase in the M/B over
time because the "true"adjustedbook value at the
end of the period might be lower than our estimate
(which is the reportedbook value minus the accu-
mulated nonoperatingaccrualsat that time). Such
overstatementarisesfromthe potentialsubstitution
between certainnonoperatingaccrualsand future
operatingexpenses.Forexample,a write-downof a
depreciable asset in the current period leads to
lower depreciationcharges in subsequentperiods
(unlessthe assetis replacedby a new one).Similarly,
the establishmentof a provision for future costs
(another negative discretionary accrual) in one
period resultsin lower recordedexpenses in subse-
quent periods. Assessing the extent of the upward
bias in our estimatedbook values is difficult,but it
is probablysmall for two reasons.First,new depre-
ciable assets, which tend to at least maintain the
previous level of depreciation,are likely to replace
most of the assetswrittenoff. Second,becausemany
of the provisions for future expenses (e.g., post-
retirementbenefits) are "settled"only over a long
period, this bias may not be pronounced.

Table 7. M/Bs for Various Growth Portfolios by Subperiod: Constant

Sample, 1968-98
HistoricalMedian Median MedianAdjusted
GrowthRate M/B M/Ba
Portfolio 1968-80 1981-98 1968-80 1981-98 1968-80 1981-98
All companies(n = 21,320) 13.5% 6.9% 1.30 1.67 1.24 1.26
By growthportfolio
1. Lowestgrowth 0.4 -1.3 0.92 1.29*** 0.98 1.05
2 5.6 5.2 1.09 1.59*** 1.10 1.24
3 9.5 9.2 1.26 1.68*** 1.23 1.37
4 13.3 12.3 1.48 1.78*** 1.42 1.59**
5. Highest growth 21.2 20.2 1.84 1.95*** 1.73 1.71
aAdjustedbook values were computed by adding back the cumulative amount of nonoperating
accrualsto the reportedbook values.
**Means(not shown) of the two subperiodsare significantlydifferentat the 5 percentlevel.
***Means(not shown) of the two subperiodsare significantlydifferentat the 1 percentlevel.

January/February 2002 69

This content downloaded from 141.216.78.40 on Sun, 27 Sep 2015 07:10:50 UTC
All use subject to JSTOR Terms and Conditions
FinancialAnalystsJournal

InvestmentImplications low-P/E stocksyield higherreturnsthanhigh-M/B

The results reportedthus far suggest that drawing
inferences from historical comparisons of ratios
such as the P/E and M/B about over- or underval-
uation of the market without adjusting for the
increased reporting conservatism in recent years
may be flawed. In this section,we demonstratehow
incorporatingconservatismmeasuresinto security
analysis might improve investment strategies.The
analysisexploits the cross-sectionalvariationin the
degree of conservatism in devising two types of
investment strategies-one based on the M/B and
the otherbased on the P/E.
Both strategies are motivated by the notion
that a low (high) M/B or P/E identifies stocks
whose values are temporarilyunderstated (over-
stated).Under these strategies,investmentis made
in low-M/B or low-P/E stocks and short positions
are held in high-M/B or high-P/E stocks.26We
ranked all companies for each year, alternatively,
by their M/Bs and their P/Es three months after
their fiscal year-ends, and we assigned them
among five portfoliosbased on these rankings.We
then measuredthe averagereturnof each M/B and
P/E portfolio over the 12 months following the
portfolioformationdate.
The resultsfor our constantsample (represent-
ing about 2,500 cases, or company-years,in each
portfolio)arepresentedin Table 8. Theyconfirmthe
finding reportedby other studies that low-M/B or
or high-P/E stocks. As reportedin the last row of
Table8 ("Strategyperformance"),the differencein
the average annual returnfollowing portfolio for-
mation between the high- and low-M/B portfolios
was 0.062and between the high- and low-P/E port-
folios was 0.083.These values are significantlydif-
ferentfromzero.
Our intentionin this analysis,however, is nei-
therto resolve these apparentanomaliesnor to test
the competing explanations for them (mispricing
or risk differentials). Rather, our aim is to show
that, within the confines of these strategies, the
trigger ratio (M/B or P/E) becomes more indica-
tive of future returns once it is adjusted for the
degree of reportingconservatismof the company.
Note that, otherthings being equal, greaterreport-
ing conservatismresults in lower book values and
a shift toward greater conservatism results in
lower earningsduring the transitionperiod. These
phenomena, in turn, lead (in an efficient market)
to artificiallyhigher M/Bs and P/Es that do not
predict future returns as would genuinely high
M/Bs or P/Es. Therefore,identifying and separat-
ing the effect of conservatism on these ratios is
expected to improve the yield to P/E or M/B
investment strategies.
Followingis a descriptionof our analysisof the
effectof reportingconservatismon these ratiosand

Table 8. Performance of M/Band P/E Strategies Conditional on Degree of Reporting Conservatism:

Constant Sample, 1968-98
M/B Strategy P/E Strategy
Postformation Postformation
Postformation AnnualReturnof Postformation AnnualReturnof
AnnualReturn ModifiedPortfoliosa AnnualReturn ModifiedPortfoliosa
Median Median
Portfolio M/B Mean Median Mean Median P/E Mean Median Mean Median
1. Lowest20%M/B
(or P/E) values 0.639 0.209 0.120 0.213 0.128 7.013 0.219 0.155 0.209 0.139
2 1.062 0.182 0.115 10.334 0.200 0.150
3 1.446 0.178 0.098 12.836 0.175 0.130
4 2.031 0.161 0.090 16.560 0.151 0.121
5. Highest20%M/B
(or P/E) valuesb 5.950 0.147 0.079 0.125 0.067 33.007 0.136 0.087 0.101 0.064
Strategyperformance 0.062** 0.041 0.088?? 0.061 0.083** 0.068 0.108?? 0.075
Note:Returnswere measuredover the year startingwith the beginningof the fourthmonth afterthe fiscalyear.
aTheseportfolioswere modified by excluding the most conservativereportersfrom Portfolio1 and the least conservativereporters
fromPortfolio5.
bInthe M/B analysis,thisportfoliowas augmentedby 187caseswith negativebookvalues.TheirM/Bs werenot reflectedin the median
ratiofor the portfolio.In the P/E analysis,this portfoliowas augmentedby 1,509cases with negative earnings.TheirP/Es were not
reflectedin the medianratiofor the portfolio.
**Significantlydifferentfromzero at the 5 percentlevel.
??Significantlydifferentat the5 percentlevel fromtheperformanceof a similarstrategythatignoresthedegreeof reportingconservatism.

70 ?2002, AIMR?

This content downloaded from 141.216.78.40 on Sun, 27 Sep 2015 07:10:50 UTC
All use subject to JSTOR Terms and Conditions

on the returnfrom investment strategiesbased on
them.We identifiedconservativeversus aggressive
reportersby one of the conservatismmeasuresused
in the study-the accumulation of nonoperating
accruals over time. We ranked all companies for
each year into five "conservatism"portfoliosbased
on the accumulationof theirnonoperatingaccruals
over the previous eight-year period. We incorpo-
rated informationon reporting conservatisminto
the M/B or P/E strategyby removingfrom the top
(bottom)portfolio cases that might belong to this
portfolio only because of their more conservative
(less conservative)reporting.Cases with the most
(least)conservativereportingwere defined as those
in the top (bottom)conservatismportfolio.
The results presented in Table 8 show that
incorporatinginformationon the degree of conser-
vatism improved the performanceof both the M/B
and P/E strategies(in terms of excess returnof the
top portfolioover the bottomportfolio)by about25
percent.As the last row shows, the averageexcess
return increased from 0.062 to 0.088 for the M/B
strategy and from 0.083 to 0.108for the P/E strat-
egy. Bothimprovementsarestatisticallysignificant.
This improvement in the strategies' perfor-
mance was achieved even though the manner by
which informationon conservatismwas incorpo-
ratedin the analysiswas fairlynaive andincomplete
becausewe did not use individualcompanies'mea-
sures of conservatism (aside from their portfolio
affiliation)and the partitioningof cases into conser-
vatism portfolios was quite rudimentary.Refine-
ments in the methods might lead to even greater
performanceimprovement.
Two lessons may be leamed from these find-
ings. First,investors give properrecognitionto the
degree of reportingconservatismin valuing com-
panies' equity by assigning conservativereporters
higher book values and earnings multiples than
aggressive reporters.This result is consistent with
our previous findings concerningthe behavior of
the M/B over time. Second, when an investment
strategybased on either of these multiples is used,
modifying that strategyby incorporatinginforma-
tion aboutthe extentof conservatismin the compa-
nies' financialstatementswould be advantageous.
Conservatism's Effect on Recent M/Bs
and P/Es. Although the exact contribution of
the increased conservatism to the higher M/Bs
and P/Es experienced in recent years is difficult
to quantify, increased conservatism alone obvi-
ously does not fully explain the rise in these ratios.
Consider, for example, the analysis of the trend in
the M/B in Figure4. The increasein this ratio over
the last two decades persisted (althoughat a much
January/February 2002
This content downloaded from 141.216.78.40 on Sun, 27 Sep 2015 07:10:50 UTC
All use subject to JSTOR Terms and Conditions
Rising Conservatism
lower rate)even afterwe correctedfor an estimate
of the effect of increased conservatism. The same
holds true for the trend in the P/E. Furthermore,
as explained in the discussion in the "Market-to-
Book Ratio" section, our design may overadjust
for the effect of increased conservatism. Thus,
although conservatism is a factor in the lower
earningsand book values reportedin recentyears,
it is undoubtedly not the only explanatoryfactor.
The impactof conservatismon financialratios
is, moreover,much more pervasive than is implied
by the findings of the preceding analysis, which
focused on the effect of the increasein reporting
conservatism on certain financial ratios. This
analysis did not provide a complete evaluation of
the role of the steady presenceof a conservativetilt
in financial reporting on financial ratios. Yet, the
combination of the level of conservatismalready
inherentin financialreportingand the changesin the
natureoftheeconomic activitiesof the corporatesector
may have had a profoundeffect on financialratios.
For example, the conservative treatmentof R&D
expenditures-the requirementto write them off as
incurred-has remainedunchangedsince the early
1970s. This R&D rule results in the omission of
certain value drivers from the balance sheet and,
therefore, other things being equal, tends to
increase the M/B. Still, as long as the amount of
R&Dexpendituresby companies does not change,
no temporal changes in the M/B would be
expected. When the effects of this conservative
accounting rule are combined with a significant
increaseof corporateinvestmentin R&D,however,
as is the case in recent decades, the effect is to
increaseM/Bs and P/Es.
Conclusions
We provided evidence of the change in the time-
seriespropertiesof earnings,cash flows, and accru-
als suggesting that the relationship between
accountingeamings and the economicperformance
of companiesis not stable over time. In particular,
the results of a series of tests are consistentwith a
trend toward increased reporting conservatism.
Although each of the tests has limitations,consid-
ered as a whole, the results suggest that financial
reporting-already conservatively biased by
accountingconventions-has becomemoreconser-
vative since the early 1980s.Our findings indicate
that the high multiples of earningsand equity that
peaked in the late 1990s were partly a result of
increasedconservatismand thus may not indicate
merely overprilcing.
At least one measureof reportingconservatism
is readily availableto analysts and can be used to
71
FinancialAnalystsJournal
improveequitystrategies.Thatmeasure,the current
accumulationof nonoperatingaccruals,canbe used
to characterizethe reportingregime of individual
companiesand, accordingly,to adjustthe earnings
and equity multiples computedfor the company.
Appendix A. Estimating the
Differential Response of Earnings
to Good versus Bad News
We estimated the following regression equation
fromall sample observationspooled acrosscompa-
nies and years:27
pSit = Cc + cc DR +
|oRit + (IhRit)(DRit)+ sit,
i, t-1
where
EPSit = EPSof company i for fiscal year t
price per share at the beginning of the
Pi, t- =
fiscal year
Rit = return of company i over the 12
months beginning 9 months prior to
the end of fiscal year t
Notes
1. Theonly "official"definitionof conservatismis thatoffered
in the glossary of FinancialAccounting StandardsBoard
(FASB)Statementof ConceptsNo. 2, namely, that conser-
vatismis "aprudentreactionto uncertaintyto try to ensure
that uncertaintyand risks inherentin business situations
are adequatelyconsidered."
2. An exampleis Statementof FinancialAccountingStandards
(SFAS)No. 106,Employer's AccountingforPostretirementBen-
efitsOtherThanPensions(1992).Otherstandardsresulting
in earlierexpenserecognitionincludeSFASNo. 68,Research
and Development Arrangements (1982),and SFASNo. 123,
Accountingfor Stock-Based Compensation (1995).(For SFAS
citationssee "FASB"in the References.)
3. ThesestandardsincludeSFASNo. 114,AccountingbyCred-
itorsfor Impairment of a Loan(1993), and SFAS No. 121,
Accountingfor the Impairment of Long-Lived Assets andfor
Long-Lived Assetsto beDisposedOf (1995).
4. Items on the FASB'sagenda determinewhich proposed
topics or projectsare sufficientlyimportantto be pursued
by the FASBand developed into a reportingstandard.
5. KrishnanandKrishnan(1997)found thatauditorsaremore
likely to resign from jobs that have a high probabilityof
litigation. Anecdotal evidence was provided in "More
Accounting Firms Are Dumping Risky Clients" (Mac-
Donald1997).Somestudieseven suggest thatthe increased
legal liabilityof auditorsinhibitsreportinginnovationand
disclosures(see Minow 1984and Kothari,Lys, Smith,and
Watts1988).
6. For example,classifyingthe purchaseas an R&Dexpense,
IBMimmediatelywroteoff the intangibleassetarisingfrom
its purchaseof Lotus.Similaractionsaredescribedin "More
FirmsWriteOff AcquisitionCosts"(MacDonald1996).
7. SEC Staff Accounting Bulletins may be found at
www.sec.gov/interps/account.shtml.
72
This content downloaded from 141.216.78.40 on Sun, 27 Sep 2015 07:10:50 UTC
All use subject to JSTOR Terms and Conditions
DRit = a dummy variable set equal to 1 if Rit
is negative and 0 otherwise.
We derived various measuresof conservatism
from the results of this regression:
* The coefficient 1 captures the incremental
responseto bad news relativeto good news. We
expected I,8to be positive under conservative
reporting.
* The ratio (P0 + Pj)/PO captures the sensitivity
of earningsto bad news relativeto the earnings
sensitivity to good news. We expected this
ratio to be greater than 1 under conservative
reporting.
* The ratio of the R2in bad-news periods to the
R2in good-news periods measuresthe relative
explanatorypower of the regressionin periods
of bad news and good news. We expected this
ratio to be greater than 1 under conservative
reporting.
* Fromthe regressionparameters,we estimated
the average downward bias in earnings-to-
price ratios as a result of conservatism.28
8. Theinterestof analystsis discussedin "Onthe Books,More
Factsand LessFiction,"NewYorkTimes(February16,1997).
The attentionof accountingstandardsetters is shown by,
for instance,the FASB'sEmergingIssues TaskForceIssue
No. 94-3, which attemptsto limit the amounts written off
as restructuringchargesuntil actualcost commitmentsare
made. On the regulation side, Arthur Levitt, the former
SECChair,frequentlyquestionedthe accountingpractices
commonly used by public corporationsto manage earn-
ings. Most of the practices (such as overstatement of
restructuringand loss provisions) are income decreasing.
(See www.sec.gov/news/speech/speecharchive/1998/
spch220.txtfor his 1998 speech.) Among the few studies
dealingwith the extentof conservatismarethose of Stober
(1996),which examined trends in M/Bs; Leftwich(1995),
which detected a conservative tilt in the FASB agenda
decisions; Basu (1997), which devised several empirical
measures of conservatismand showed that the level of
conservatismvarieswith changesin auditors'legal liability
exposure;andGivolyandHayn (2000)andHolthausenand
Watts (2001),which provided evidence on the time-series
patternsof conservatism.Among the studies of the cross-
country comparisonsof reportingconservatismare Ball,
Kothari,and Robin(1999)and Pope and Walker(1999).
9. Thetheoreticalframeworkdevelopedby Felthamand Ohl-
son (1995)suggests the M/B as a measureof conservatism.
10. Net income (or net loss) refers to the "bottomline" net
income (i.e.,incomeaftergains or losses fromdiscontinued
operations,extraordinaryitems, and the cumulativeeffect
of changesin accountingprinciples).
11. The finding that earningsperformanceover the past two
decades is lacklusterruns contraryto the common belief
thatvigorous earningswere one of the causesfor the surge
in the stockmarketin this period.Thisbelief is reflectedin
many analyses in the financialpress, such as Bongiomo
(1995),Clark(1997),and Spiers(1996).
?2002, AIMRS

12. Totestforsignificance,t-testswereperformedon theresults
of the subperiodsto assess whether the differencein the
mean ROAbetween each adjacentsubperiodis significant.
All t-values indicatea significantdecline (at the 1 percent
significancelevel).
13. As noted in the "Sample"section, the use of a constant
sample for the years 1968-97 assures comparabilityover
time because the sample each year consisted of the same
companies.In some tests,however,as in this case,we have
extended the period over which results for the constant
samplearepresented.Althoughtheresultsfortheadditional
years are not strictlycomparablewith the 1968-97period,
they are still more comparablethan the yearly analysisfor
the full sample, whose compositionchanged dramatically
over the years.
14. Similar results (not reported)were obtained for the full
sample.
15. Themotivationfor this classification,suggested by Francis
and Schipper(1999),was based on the notion that compa-
nies in high-tech industries are likely to have substantial
unrecordedintangibleassets.
16. Theaverage(geometric)annualgrowthratein nominalsales
of the sample companiesduring the period from 1956-98
was 9.2 percent.
17. To the extent that losses do not result in the creationof a
deferred-taxasset (representingthe futuretaxbenefitsaris-
ing from loss carryforwards),the effectivetax rate may be
greaterthanthe statutoryrate.
18. We obtained our data for CFOfor 1987-1998from Com-
pustat Item 308. For earlieryears, we derived CFOon the
basis of funds from operations(FFO),which is Compustat
Item 110,as follows:CFO= FFO-(ACurrentassets + ADebt
in currentliabilities- ACurrentliabilities- ACash).
19. Thedeflatorof the cashflow measure,totalassets,depends
to some extent on accountingprocedures,but because it
also serves as the deflatorfor ROA,the earningsmeasure,
any differencebetweenthe cashflow ratioand the earnings
measureis unlikelyto be affectedby accountingpractices.
We also conducted the analysis using total sales as the
deflator,with essentiallythe same results.
20. We excludeddepreciationfrom accrualsbecauseits rever-
sal is not capturedby cash flows from operations.Rather,
the related cash outflows (arisingfrom the acquisitionof
long-livedassets)arereportedas cashflows frominvesting
activities.
References
Ball, R., S.P. Kothari, and A. Robin. 1999. "The Effect of
InternationalInstitutionalFactorson Propertiesof Accounting
Earnings."Workingpaper,Universityof Rochester.
Basu,Sanjoy.1983."TheRelationshipbetween Earnings'Yield,
MarketValue and Retum for NYSECommon Stocks:Further
Evidence." Journal of Financial Economics,vol. 12, no. 1
June):129-156.
Basu, Sudipta. 1997. "The Conservatism Principle and the
AsymmetricTimelinessof Earnings."JournalofAccountingand
Economics, vol. 24, no. 1:3-37.
Bongiorno,L. 1995."Hot Damn, What a Year!"BusinessWeek,
no. 3414(March6):98-100.
Campbell,JohnY.,and RobertJ.Shiller.1998."ValuationRatios
and the Long-RunStock MarketOutlook."Journalof Portfolio
Management, vol. 24, no. 2 (Winter):11-25.
Clark,K.1997."TheseArethe GoodOldDays."Fortune,vol. 135,
no. 11 (une 9):74-86.
January/February 2002
This content downloaded from 141.216.78.40 on Sun, 27 Sep 2015 07:10:50 UTC
All use subject to JSTOR Terms and Conditions
Rising Conservatism
21. As in the earliertests, the test of increasedvariabilitywas
based on a comparisonof each of the subperiodswith the
subperiodthat preceded it. The F-statisticsare significant
acrossall pairedcomparisonsfor the full and constantsam-
ples at the 1 percentsignificancelevel,exceptforthecompar-
ison of 1961-1965with 1966-1970for the constantsample.
22. Theuse of the ratioof the aggregatevalues, ratherthanthe
mean of the ratiosover the sample,has the advantagesof
both value weighting the observationsand avoiding the
meaninglessratios obtainedfor cases with negative book
values.
23. As in the analysis of the M/B, the trend in the P/E (not
reportedhere) reveals an increasethat becomes less pro-
nounced in recentyears once earningsare adjustedfor the
accumulationof negative nonoperatingaccruals.The five-
year moving averageof the aggregateP/E for our constant
sample(computedeachyearas the aggregatemarketvalue
of the sample companiesdivided by their aggregateeam-
ings) was 8.9 for 1979and 19.3for 1998.Whenthe P/E was
adjusted for conservatism(through the extractionof the
accumulationof negative discretionaryaccrualsfrom the
eamingsnumbers),this ratiostillincreasedoverthe 20-year
periodbut only from5.1 to 9.5.
24. Underlyingthe forward-lookingapproachis the assump-
tion that investorsprojectfuturegrowthwithout bias. The
backward-lookingestimateassumes that investorsproject
futuregrowthbased on past growthrates.
25. Use of the forward-lookingapproach to estimate the
expectedgrowthrateled to essentiallythesameconclusions.
26. For furtherdiscussion of the M/B and the P/E strategies,
see Fama and French (1992), Lakonishok,Shleifer, and
Vishny (1994),and Basu (1983).
27. See Basu (1997)for justificationof the use of a "reverse"
regression.In estimatingthe regression,we truncatedthe
most extreme1 percentEPSIP values each year.
28. The bias was measured as (1/k - f3o)RGood prob(Good) -
(0o + ,13- 1/k)RBad prob(Bad),where RGood (RBad)is the
mean returnover a good-news (bad-news)period,defined
as a period with positive (negative) returns, and
prob(Good)[prob(Bad)]is the relativefrequencyof good-
news (bad-news)periods.Theparameter1/k, the risk-free
rate, was estimatedby the interceptof the regression(see
Pope and Walker).
Cole, K., J. Helwege, and D. Laster. 1996. "Stock Market
ValuationIndicators:Is ThisTimeDifferent?"FinancialAnalysts
Journal,vol. 52, no. 3 (May/June):56-64.
Collins,D.W.,E.L.Maydew, and I.S.Weiss. 1997."Changesin
the Value-Relevanceof Earningsand BookValuesover the Past
FortyYears."Journalof AccountingandEconomics,
vol. 24, no. 1
(December):39-67.
Dreman,D. 1998."It'sTulipTimeon WallStreet."Forbes,
vol. 161,
no. 10 (May18):325.
Elliott,J.A., and W.H. Shaw. 1988. "Write-Offsas Accounting
Proceduresto ManagePerceptions." Journal ofAccounting,vol. 26
(Supplement):91-119.
Fama,E., and K. French.1992."TheCross-Sectionof Expected
StockReturns."JournalofFinance,vol. 47, no. 2 (June):427-465.
Feltham,G.E., and J.A. Ohlson. 1995. "Valuationand Clean
Surplus Accounting for Operatingand FinancialActivities."
Contemporary Accounting vol. 11,no. 2 (Spring):689-731.
Research,
73
FinancialAnalystsJournal
Financial Accounting Standards Board. 1982. Researchand
DevelopmentArrangements,Statement No. 68. Norwalk, CT:
Financial Accounting Standards Board of the Financial
AccountingFoundation.
. 1992. Employer'sAccountingfor PostretirementBenefits
OtherThanPensions,StatementNo. 106.Norwalk,CT:FASB.
. 1993.Accountingby Creditors for Impairmentof a Loan,
StatementNo. 114.Norwalk,CT:FASB.
. 1995.AccountingfortheImpairment of Long-LivedAssets
andfor Long-Lived Assetsto be DisposedOf, StatementNo. 121.
Norwalk,CT:FASB.
.1995.Accountingfor Stock-BasedCompensation,
Statement
No. 123.Norwalk,CT:FASB.
. 2001. Business Combinations,Statement No. 141.
Norwalk,CT:FASB.
Francis,J., and K. Schipper.1999. "HaveFinancialStatements
Lost TheirRelevance?"Journalof AccountingResearch,vol. 37,
no. 2 (Autumn):319-352.
French, K.R., and J.M. Poterba. 1991. "WereJapaneseStock
Prices Too High?"Journalof FinancialEconomics, vol. 29, no. 2
(October):337-363.
Givoly, D., and C. Hayn. 1994. "SpecialItems-Information
Content and Earnings Manipulations." Working paper,
Universityof Califomiaat Irvine.
. 2000. "TheChanging Time-SeriesPropertiesof Eam-
ings,CashFlowsandAccruals:Has FinancialReportingBecome
More Conservative?"Journalof Accountingand Economics, vol.
29, no. 3 (June):287-320.
Gray, S.J. 1980. "The Impact of International Accounting
Differencesfrom a Security-AnalysisPerspective."Journalof
AccountingResearch, vol. 18, no. 1 (Spring):64-76.
Hayn, C. 1995."TheInformationContentof Losses."Journalof
AccountingandEconomics, vol. 20, no. 1 (September):125-154.
Holthausen,R.W.,and R.L.Watts.2001. "TheRelevanceof the
Value-RelevanceLiteraturefor FinancialAccountingStandard
Setting."Journalof Accountingand Economics, vol. 31, nos. 1-3
(September):3-75.
Kothari,S.P.,T. Lys, C.S.Smith,and R.L.Watts.1988."Auditor
Liability and InformationDisclosure."Journalof Accounting
AuditingandFinance,vol. 3, no. 4 (Fall):307-339.
74
This content downloaded from 141.216.78.40 on Sun, 27 Sep 2015 07:10:50 UTC
All use subject to JSTOR Terms and Conditions
Krishnan, J., and J. Krishnan. 1997. "Litigation Risk and
Auditor Resignations." Accounting Review, vol. 72, no. 4
(October):539-560.
Lakonishok,J., A. Shleifer,and R. Vishny. 1994. "Contrarian
Investment,Extrapolation,and Risk."JournalofFinance,vol. 49,
no. 5 (December):1541-78.
Leftwich,R. 1995. "The Agenda of the FinancialAccounting
StandardsBoard."Workingpaper,Universityof Chicago.
MacDonald,E. 1996."MoreFirmsWriteOffAcquisitionCosts."
WallStreetJournal(December2):A2.
. 1997. "MoreAccounting Firms Are Dumping Risky
Clients."WallStreetJournal(April23):A2
Miller, J.G.,and T.E. Vollman. 1985. "The Hidden Factory."
Harvard Business Review, vol. 63, no. 5 (September-
October):142-150.
Minow, N.N. 1984. "Accountants'Liabilityand the Litigation
Explosion." Journal of Accountancy, vol. 158, no. 3
(September):70-86.
Pope, P., and M. Walker.1999. "InternationalDifferencesin
Timeliness, Conservatism and Classification of Earnings."
JournalofAccountingResearch,
vol. 37 (Supplement):53-99.
Skinner,D.J.1994."WhyFirmsVoluntarilyDiscloseBadNews."
vol. 32, no. 1 (Spring):38-60.
JournalofAccountingResearch,
Speidel, S.L., and V.B. Bavishi. 1992. "GAAP Arbitrage:
Valuation Opportunities in International Accounting
Standards."FinancialAnalystsJournal,vol.48, no.6 (November/
December):58-66.
Spiers,J. 1996. "The Profits Flowed." Fortune,vol. 133, no. 8
(April29):260-261.
Stober,T.L. 1996. "Do Prices Behave As If Accounting Book
ValuesAre Conservative?Cross-SectionalTestsof the Feltham-
Ohlson(1995)ValuationModel."Workingpaper,Universityof
Notre Dame.
White, C. Barry.2000. "WhatP/E Will the U.S. Stock Market
Support?"FinancialAnalystsJournal,vol. 56, no. 6 (November/
December):30-38.
Wyatt,J. 1996. "TheIncredible,Death-DefyingStock Market:
Love It and Fear It." Fortune,vol. 134, no. 12 (December
23):110-118.
X2002, AIMR?