Investigating the effect of conservatism on abnormal returns at the portfolio level

Document Type : Original Article

Authors

Department of Accounting, Islamic Azad University, Central Tehran Branch, Tehran, Iran.

Abstract

Abstract
The purpose of this study is to investigate the effect of conservatism on stock abnormal returns at the portfolio level. Earnings that often consist of accruals do not persist in future periods, knowing that investors not paying attention to less persistence of accruals, which causes a negative relationship between accruals and future abnormal returns. On the other hand, conservatism is the asymmetrical verification requirements for gains and losses. Greater degree of verification required for gains versus losses. Hence expected increase in conservatism led to increase earnings persistence and reduce abnormal returns.
To examine the issue, hedge portfolios formed by assigning stocks into quartiles by using a dual sorting based on their magnitude of annual deflated accruals then degrees of conservatism quartiles within each accrual quartile. For 208 companies (4*4 portfolios per year) during the years 2011-2018 the abnormal returns of the portfolios were calculated and compared using spss.26 software. The results showed that the return of a hedge portfolio that is long in low accrual quartile and short in high accrual quartile firms that also have a lower overall degree of conservatism is greater than the returns of a similar hedge portfolio that invests in higher overall degree of conservatism.

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