Accounting Conservatism, Earnings Persistence and Pricing Multiples on Earnings

Abstract

In this paper, we examine the effect of accounting conservatism on earnings persistence and pricing multiple on earnings. One of the most obvious factors, among those that cause accounting earnings to reverse over time, is accounting conservatism. By making more conservative accounting choices, a company faces mismatching between current-period revenues and future period expenses so that earnings have more temporary components and become less persistent. This implies that earnings are less persistent under more conservative accounting choices than under less conservative accounting choices. We hypothesize that more conservative earnings are less persistent than less conservative earnings. Moreover, according to Ohlson (1995) model, where price is expressed as a linear combination of equity book value and earnings, the more (less) persistent earnings obtain larger (smaller) pricing multiples. Thus, we hypothesize that the pricing multiple on more conservative earnings is smaller than that on less conservative earnings. Base on sample from 88 listed companies in Tehran stock exchange during the period of 1998-2007, our findings suggest more conservative earnings are less persistent than less conservative earnings and the pricing multiple on more conservative earnings is smaller than that on less conservative earnings.

Keywords

• accounting conservatism
• earnings persistence
• pricing multiples on earnings (p/e)