Journal of Applied Finance & Banking

The Effect of Accounting Conservatism on Equity Valuation: Evidence from Corporate Life Cycle

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  • Abstract 

    This study examines the effects of accounting conservatism on equity mispricing. We adopt Basu’s and Khan and Watt’s C_Score models to measure accounting conservatism and use EBO and RKRV valuation models to calculate a stock’s intrinsic value. Additionally, we consider the effects of the corporate life cycle on the above relationship. The findings show that investors would make more positive valuations if a company has a high accounting conservatism in the previous period. Second, accounting conservatism has a deferred and positive effect on equity valuation. Third, the equity value of a company at the growth stage tends to be overvalued, while that of a company in maturity stage is likely to be undervalued. Finally, accounting quality impacts equity valuations, i.e. the better, then the less undervalued it is. Overall, we provide the evidences that accounting conservatism does matter to equity valuation, especially with the change of corporate life cycle.

    JEL classification numbers: G14, G32
    Keywords: Accounting conservatism, Equity valuation, Corporate life cycle, Accounting quality, Mispricing.