We connect conservative accounting to the cost of capital by developing an accounting model within an asset pricing framework. The model has three distinctive features: (1) transaction-cycle-conformity, where the book value equals the value of cash at the beginning and the end of a cash-to-cash transaction cycle; (2) a revenue recognition principle, where uncertainty affects the amount of revenues recognized; (3) a matching principle, where expenses are matched with revenue with a conservative bias due to uncertainty. We demonstrate how the growth rate of expected earnings, the accruals-to-cash ratio, and the expected earnings yield relate to the expected stock return.
Penman, Stephen, and Xiao-Jun Zhang. "A Theoretical Analysis Connecting Conservative Accounting to the Cost of Capital." Journal of Accounting and Economics 69, no. 1 (February 2020): 101236.
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