2 The Punch Line: Basu documents that earnings are much more highly correlated with bad news (negative stock returns) than with good news (positive stock returns) We argue that earnings conservatism is related to the conservatism in the balance sheet at the beginning of the period (most straight forward way to see – lower of cost or market rules - suggest that recognition of bad news is a function of the relation between book and market, recognition of good news is not) We use market to book to measure balance sheet conservatism and document a very strong negative relation between market to book and earnings conservatism We further document that this relation is principally driven by the accrual component of earnings
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