Reporting Conservatism, Loss Reversals, and Earnings-based Valuation
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4262-02.pdf
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Author(s)
Joos, Peter R.
Plesko, George A.
Date Issued
April 14, 2003
Series/Report no.
MIT Sloan School of Management Working Paper;4262-02
Abstract
We study the determinants of losses and their increased frequency over time to
understand their implications for the use of financial statements in valuation. We find
the properties of losses change between 1971-2000 both in terms of the cash flow
and accruals components. Departing from prior research, we explicitly model the
estimated likelihood of loss reversal. We find firms estimated to be least likely to
reverse have unusually large negative cash flows and accruals, comprised of relatively
large amounts of R&D expenditures and Special Items. We also find the market
assesses both the effect of reporting conservatism and the attractiveness of abandoning
the investment in the firm when it prices losses. We interpret this as evidence that the
probability of loss reversal summarizes financial information useful to investors and
serves as a proxy for the earning power of assets when the firm reports a los
Subjects
Earnings
Losses
Conservatism
Cash Flows
Accruals
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