On the Conditional Conservatism Measure: A Robust Estimation Approach

James A. Ohlson
Hong Kong Polytechnic University and Cheung Kong Graduate School of Business
johlson@stern.nyu.edu
Seil Kim
New York University
seil.kim@stern.nyu.edu

August 2, 2015

Abstract
Recent research, due to Patatoukas and Thomas (2011) and Ball et al. (2013), focus on
Basus (1997) conditional conservatism measure and the existence of a denominator effect
whether the difference between the earnings-return coefficients between bad and good news
firms (the Basu coefficient) is only due to the beginning-of-year price deflator. We address this
issue head-on by applying the Theil-Sen (TS) estimation method which does not depend on the
scaling of variables; the same coefficient estimates are obtained whether or not the regression
equation is scaled by beginning-of-year price. Moreover, the TS estimates are intrinsically
insensitive to outliers. Results show the following: (i) the Basu coefficient remains positive
under the TS method; (ii) the Basu coefficient under the TS method is similar to estimates from
OLS without scaling but much smaller than what scaled OLS shows; (iii) the scaled OLS
estimates appear to be influenced by a few outlier firms with negative returns and material
losses; and (iv) OLS-based estimates are more volatile due to estimation error. In sum, the
denominator effect does not overturn Basus hypothesis but the magnitude and variation of the
Basu coefficient is much smaller than what traditional results show.

Electronic copy available at: http://ssrn.com/abstract=2644423

Introduction.
Recent work on the Basu (1997) conditional conservatism measure has raised concerns
that the standard conclusion is an artifact due to the price denominator. 1 Specifically, Patatoukas
and Thomas (2011) replace the dependent variable, current earnings, with lagged earnings and
still find the asymmetric earnings-return coefficient for good news vs. bad news firms (the Basu
coefficient). The results seemingly overturn the Basu hypothesis; it attributes the price deflator
applied to all variables as the culprit. Ball et al. (2013), however, argue otherwise. Ball et al.
(2013) control for the price deflator by grouping firms with similar price and re-estimate the
Basu coefficient. But the regressions still require deflating by price, so it is not clear whether the
real econometric issues have been adequately resolved.
Both of the above-mentioned papers use indirect assessments of the role of the deflator in
the estimation of the two model coefficients. A direct test starts from the observation that one
can posit a linear model that has multiplied both sides of the equation using the deflator in the
original model. A direct test compares the resulting OLS estimates with those in the original
model. We consider this aspect though, of course, such a preliminary evaluation must recognize
the inherent drawback due to the built in, rather extreme, heteroscedasticity.
A more potent approach bypasses the scaling issue by relying on an estimation method
where the scaling of variables has no effect whatsoeverit would yield exactly the same
coefficient estimates. Such an estimation method is due to Theil (1950) and Sen (1968),
commonly referred to as the TS estimation method. Added to this advantage, the TS method
eliminates the need to be concerned with excess influence of outliers or poor goodness-of-fit as
compared to OLS. The literature in statistics has underscored the efficiency merits of TS
1

Other criticisms of the Basu estimation include biases from endogeneity (Dietrich et al. 2007) and from using
aggregated summary measures, stock returns and net income, rather than using individual news events and their
effect on earnings (Givoly et al. 2007).

Electronic copy available at: http://ssrn.com/abstract=2644423

compared to OLS (Peng et al. 2008; Wilcox 2010). In accounting valuation settings, it has been
applied by Ohlson and Kim (2015). This paper argues that TS results in more stable, and thus
efficient, estimates as compared to OLS.
We estimate the Basu coefficient in annual cross-sections with scaled and unscaled OLS
models and TS, which is indifferent to scaling, using a sample of S&P 1500 firms in a ten year
period (2001-2010). All three methods show a positive Basu coefficient: a larger earnings-return
coefficient for bad news firms compared to that of good news firms. However, scaled OLS, the
conventional estimation method, yields Basu coefficients over twice as large as TS or unscaled
OLS. This difference is mostly driven by steeper slopes for bad news firms in the scaled OLS
estimation. Using scatter plots, we show that this upward bias in earnings-return coefficients for
bad news firms is due to outliersa few firms with negative returns and large losses. Overall,
our results support Ball et al. (2013) that the Basu coefficient is not an artifact of the beginningof-year price deflator but we also find that OLS based estimates of the Basu coefficient are
sensitive to outliers.
Because OLS estimation is sensitive to outliers, OLS-based Basu coefficients are subject
to greater estimation error compared to TS estimates. Several observations support this claim.
First, the earnings-return coefficients for good and bad news firmswhere the difference
between the two is the Basu coefficientalways have a positive sign under TS estimation
whereas OLS frequently yield an incorrect negative sign. A negative correlation between
earnings and returns seems unreasonable and suggest estimation error in OLS. Second, TS
estimates have better goodness-of-fit compared to OLS estimates. Our two measures of
goodness-of-fit consistently show that TS fits a line that better represents the data points. Lastly,
OLS estimates of the Basu coefficient fluctuate more widely across years. Given that OLS

estimates are more likely to have an incorrect sign and worse goodness-of-fit, the fluctuation
seems to reflect estimation error rather than changing supply and demand for conditional
conservatism over time.
Additionally, we test whether winsorizationthe conventional way to reduce the
influence of outliersis effective in reducing the OLS estimation error. 2 We apply OLS with
winsorization and find that results are similar to those estimated without any treatment; the Basu
coefficient estimated using scaled OLS with winsorization becomes smaller but still much larger
than TS or unscaled OLS estimates. Also the volatility of OLS estimates across years remains
greater compared to that of TS.
To summarize, the following findings stand out. First of all, the data analysis supports the
Ball et al. (2013) contention that a positive Basu coefficient is not not an artifact of the deflator.
That said, the traditional use of OLS, which uses a deflator, leads to estimates of the Basu
coefficient that materially inflates the coefficient magnitudes; from this perspective there is some
limited validity to the Patatoukas and Thomas (2011) claim. As to the use of OLS more
generally, with or without scaling or winsorization, it leads to relatively large estimation errors
that naturally ought to be mitigated by robust estimation methods, as suggested by the use of the
TS estimation method. 3

Empirical Test.
The Basu coefficient is conventionally estimated using the following piecewise model:
EPSt / Pricet-1 = a0 + a1 D + a2 Returnt + a3 DReturnt + noiset

2
3

Basu (1997) also applies a top and bottom 1% winsorization.

LAD (least absolute deviation) among other robust estimation methods yields similar conclusions.

(1)

where EPS is earnings per share; Price is stock price; Return is 12-month stock return from three
months after fiscal year starts; and D is an indicator variable that equals 1 if Return is negative
and 0 otherwise. This is equivalent to two separate estimations of earnings-return regressions for
bad news (D=1) and good news (D=0) subsamples:
EPSt / Pricet-1 = b0 + b1 Returnt + noiset

(2)

The coefficient a3 in equation (1), the so-called Basu coefficient, is equivalent to the
difference of b1 coefficients for bad news vs. good news firms.
To examine how the Basu coefficient is affected by the deflator, we also consider an
unscaled model. Specifically, the unscaled earnings-return model is equivalent to multiplying
Pricet-1 to equation (2):
EPSt = b0 Pricet-1 + b1 [Pricet + Dividendst Pricet-1] + noiset

(3)

where Dividendst is net dividend per share. 4,5 TS is a natural alternative given its irrelevance to
scalars; both scaled and unscaled models yield the same results when using TS. However,
because unscaled models are prone to issues related to heteroscedasticity, OLS requires deflating
for size. TS has the added benefits of robustness against outliers and Ohlson and Kim (2015)
show that TS has better goodness-of-fit compared to OLS.

One could also consider the unscaled model as the correct specification to estimate earnings-return relations,
where the association between earnings (EPS) and news is calculated after controlling for expectations included in
beginning-of-year price.
5
Notice that when using the original Basu (1997) model, equations (2) and (3) are not equivalent because Pricet-1 in
the deflator is measured at the beginning of the fiscal year whereas the Pricet-1 used to calculate stock returns is
measured at three months past the beginning of the fiscal year. This is intended to avoid including stock market
reaction to the previous years earnings announcement. We use Pricet-1 from the beginning of the return
accumulation period as the deflator to retain consistency.
The equivalence of equations (2) and (3) would also not hold if we use market adjusted returns rather than raw
returns. Thus, we use raw returns throughout the paper but our inferences do not change when returns are adjusted
by the equal- or value-weighted market index.

We run separate regressions for bad and good news subsamples and take the difference of
the two estimated coefficients because it sidesteps the singularity problem in TS estimation and
is equivalent to the piecewise model. 6
The sample consists of S&P 1500 firms during 2001-2010 which we use to estimate the
Basu coefficient in annual cross-sections. Three estimation methodsTS, scaled OLS, and
unscaled OLSare used to estimate the Basu coefficient. The ten-year sample period is intended
to allow comparison of the magnitude and change of Basu coefficient estimates across the
methods. 7

Comparison of TS vs. OLS Estimates.

Table I reports our main results on the Basu coefficient estimates for TS, scaled OLS, and
unscaled OLS. In three columns for each estimation method are the coefficient estimates from
the earnings-return model run for bad news and good news firms separately, and the difference
between the two coefficient estimates, which is equivalent to the Basu coefficient in the
piecewise model.
Before comparing the magnitude of the Basu coefficients across estimation methods, we
first consider the reasonableness of estimates from the separate earnings-return regressions. As a
first-cut, we check whether the coefficients have the correct sign, since the earnings-return
association should be positive. OLS based estimates are negative in several cases for good news
firms. For scaled OLS, negative earnings-return relations come up in five out of ten years.
Unscaled OLS shows negative earnings-return coefficients for good news firms in two years,

6
7

We elaborate on the singularity problem in TS estimation in the Appendix.

Using longer time-series data yield the same conclusion, as we partly demonstrate in Figure II.

2002 and 2010. TS, however, yields positive coefficients in all years for both good and bad news
firms. 8 Thus, TS is the only estimation method that comes up with reasonable outcomes.
Next, we look at the stability of coefficients based on the premise that the earnings-return
relation should be relatively constant across time. The coefficients in the bad news column
range in [0.09, 0.21] for TS while these range in [0.16, 0.49] for scaled OLS and [0.02, 0.51] for
unscaled OLS, respectively. The two OLS methods yield coefficients in a range about three to
four times wider than TS. Comparing the ranges of coefficients in the good news columns we
find similar results. TS coefficients come in a tight range of [0.00, 0.03] but scaled OLS and
unscaled OLS coefficients are in wider ranges of [-0.05, 0.02] and [-0.09, 0.12], respectively.
Next we move on to the Basu coefficient in the bad-good news columns. Three results
stand out when comparing the Basu coefficients across the three estimation methods. First,
notably the Basu coefficient is positive in all ten years for all three estimation methods except for
one year using unscaled OLS. This suggests that a positive Basu coefficient is not likely an
artifact of the scalar. Second, however, the scaled OLS methodthe conventional method in the
literatureyields Basu coefficients that are more than twice as large as TS or the unscaled OLS
method. The median value over ten years for the scaled OLS method is 0.31 which is consistent
with Basu (1997) and replications by Patatoukas and Thomas (2011) and Ball et al. (2013),
whereas the median values are 0.09 and 0.08 for TS and unscaled OLS, respectively. Thus, while
scaling does not overturn the results its effect seems non-trivial.
Third, as an issue separate to the denominator effect, Basu coefficients estimated using
the two OLS methods show greater fluctuation across years. The standard deviation is 0.05 for
TS compared to 0.12 and 0.14 for scaled and unscaled OLS, respectively. The ranges of OLS
based estimates are about three to four times wider than TS based estimates. Notably, this
8

The TS coefficient for good news firms in 2005 is 0.004; it is reported as zero due to rounding.

difference is driven by the large variation from the bad news firms. We conjecture that the
fluctuation in OLS estimates arise due to estimation error and provide supporting evidence in the
following sections.

Estimation Error and Goodness-of-fit.

Because greater fluctuation in OLS-based Basu coefficients may reflect economy-wide
changes in demand and supply for conservatism rather than arise as an artifact of outliers and
estimation error, we compare the goodness-of-fit of TS vs. OLS estimation. As in Ohlson and
Kim (2015) we rely on two measures of goodness-of-fit: the median absolute percentage error
and the relative accuracy score. 9
We report the comparison of goodness-of-fit between TS vs. OLS methods in Table II.
TS has unquestionably better goodness-of-fit. As reported in Panel A, in all years, when
comparing TS vs. OLS, relative accuracy scores exceed 50%; that is, TS fitted values come
closer to actual values than OLS fitted values more frequently. These scores are also statistically
significant at the 1% level in all cases. In Panel B, comparing the median absolute percentage
errors, TS has smaller error than both scaled and unscaled OLS in all years while it is hard to tell
which of the two OLS estimation methods is better. Overall, the greater goodness-of-fit of TS
estimates suggest that OLS-based estimates contain estimation error rather than reflect changes
in reality.

The relative accuracy score is computed as follows. Let I(x) equal one if x > 0 and zero otherwise. Consider two
models, M and N, with fitted values yMi and yNi. Let yi denote the actual value given i = 1, , n data points.
Calculate
1/n I{ | yMi yi | | yNi yi | }
Given an i-independent distribution, under the null the expected value is 50 percent and the distribution is binomial.
Note that the metric works regardless of the methodology that projects the dependent variable.

Influence of Outliers.
Since the relative instability of OLS estimates is likely due to estimation error than
changing economic fundamentals (Givoly et al. 2007; Ohlson and Kim 2015), we conjecture that
outliers have undue influence on the OLS estimates. 10 The greater fluctuation of estimates in the
bad news sample suggests that outliers lie within this subsample. It is also natural to speculate
that, because earnings have a left-skewed distribution, a few observations with large losses pull
the slope down, making the OLS slopes for bad news firms become steeper. To evaluate our
conjecture about outliers having undue influence on the OLS coefficients, especially for bad
news firms, we look at scatter plots. This is a simple but effective approach given that we
explore the relationship between two variables.
Figure I displays three scatter plots of observations for years 2005, 2006, and 2010.
These years are chosen because they exemplify the difference between TS and OLS estimates
but other years show very similar results. Fitted slopes for TS and OLS are overlaid on the plot
with TS in thick red and OLS in thinner blue lines, respectively. For bad news firms, the OLS
slope is much steeper than the TS slope. A few bad news firms with large losses drive down the
bad news slope for OLS, resulting in a larger differential between bad and good news firms. TS,
by contrast, being less affected by these observations fits a much flatter slope.

OLS with Winsorization.

10

Givoly et al. (2007) also show that Basu coefficients are not stable by comparing them to other conservatism
measures such as book-to-market ratios. However, they attribute this to the Basu coefficient having a downward bias
because differential earnings-return relationship for bad vs. good news, while clear for individual economic events,
becomes blurry when looking at aggregated summary measures such as annual earnings and stock returns.

In this section we examine whether winsorization effectively reduces the influence of

outliers in OLS estimation. We apply a top and bottom 1% winsorization of all variables each
year and repeat the estimations. 11
In Table III, we report the estimation results of scaled and unscaled OLS after
winsorizing the variables. Comparing the estimates with winsorization and those without (in
Table I), we see that the estimates become more stable across years with winsorization. Notably,
many of the incorrect signs for good and bad news firms go away and there are no more
negative Basu coefficients. Still, a negative coefficient on an earnings-return regression in 2003
using scaled OLS remains, suggesting that winsorization does not completely eliminate outliers.
Also, focusing on the summary statistics over ten years, we see that the overall results do not
change much. 12 For scaled OLS, the median Basu coefficient is 0.21, still much larger than the
TS estimates, and the standard deviation is 0.11 not much different from that without
winsorization.
As a clearer visual representation, Figure II shows the Basu coefficients estimated using
scaled OLS, scaled OLS with winsorization, and TS for each year. We add a few years to the
original sample and the sample period now spans 1994-2012. Scaled OLS without winsorization
(light blue, solid line) and scaled OLS with winsorization (dark blue, dotted line) move closely
together, which shows that winsorization does not have much effect. Also, these two lines show
a slight downward trend up to 2000 and a bumpy upward trend thereafter. Using OLS, one may
interpret the results as conditional conservatism decreasing until 2000 and then rebounding. In

11

To be sure, Basu (1997) acknowledges that without winsorization the slope coefficients are biased upward while
the model fit becomes worse.
12
This is consistent with Leone et al. (2014) who conclude that winsorizing has only a modest impact on
parameter estimates.

contrast, TS (red, double line) is mostly constant over time with much less variation compared to
OLS. TS estimates suggest that there is no material change in conditional conservatism.

Another approach to test the Basu hypothesis.

Quite aside from whether the Basu coefficient ends up being positive for most years, the
hypothesis of a positive coefficient can be tackled via a more direct evaluation. This approach
will in some ways subordinate the scaling issue per se and instead focus squarely on efficient
estimation and the meaningfulness of the Basu coefficient.
We compare the goodness-of-fit, within each estimation method, using the piecewise
model (equation 1) to using a simple linear earnings-return model (equation 2). In other words,
we examine whether allowing for bad news firms and good news firms to take on different
earnings-return coefficients improves goodness-of-fit compared to fitting both type of firms in a
single earnings-return relation.
The results, reported in Table IV, support our previous finding that the Basu coefficient is
significantthe earnings-return relation is asymmetric for bad vs. good news firms. In Panel A,
we compute the relative accuracy score using the same estimation method but different models:
piecewise vs. simple linear. All years except three in the case of unscaled OLS exceeds
50%the estimates using the piecewise model get closer fitted values than the single earringsreturn model more frequently. Except in 2008 and 2010 for TS, these improvements are
statistically significant at the 1% level. In Panel B, we report the median absolute percentage
errors computed for the three estimation methods using the simple linear model. These should be
examined in comparison to the corresponding numbers in Panel B of Table II. Except for two
cases for TS (in 2003 and 2008) and two cases for unscaled OLS (in 2007 and 2008), the

10

piecewise model has better fit compared to the simple linear model. In sum, both goodness-of-fit
measures, median absolute percentage error and relative accuracy score, show improvements
when using the piecewise model compared to the single earnings-return model.

Concluding Remarks.
TS estimation is applied to directly test whether the Basu coefficient is an artifact of a
bias due to the deflator, beginning-of-year price. We find that the Basu coefficient is positive
using TS estimation, which does not consider a particular scalar. In addition, we show that OLSbased Basu coefficient estimates are inflated and more volatile compared to those estimated
using TS. Especially, scaled OLS, the primarily used method for Basu coefficient estimation,
results in values about four times larger and two times more volatile compared to TS. We also
show that the fluctuations in the Basu coefficients based on OLS methods are likely due to
estimation error rather than changing levels of conditional conservatism. Thus, previously
documented levels of conditional conservatism based on the Basu coefficient and its crosssectional and time-series variation may be unduly influenced by outliers.

11

Appendix. Dealing with the Singularity Problem in TS estimation.

In this study, we run separate regressions for bad and good news firms and take the
difference of the two coefficients rather than run one piecewise regression. This particular
research design is due to TS running into a singularity problem when the model involves
categorical variables. As an example, consider the Basu model with three regressors and a
constant (equation 1). TS estimation requires sampling four observations and fitting a line with
zero degrees of freedom. Then we repeat this process for all possible combinations of four
observations after which we select the median value of all coefficient estimates. However, for
example, if the four observations are all good news firms (D=0), we cannot estimate two of the
four coefficients. While there are various ways to get around this problem, we run separate
regressions for bad and good news subsamples because it avoids the singularity problem and is
equivalent to the piecewise model.
Other methods we considered are: (1) sampling two good news firms and two bad news
firms, which guarantees non-singularity but restricts the sampling process to a subset of all
possible combinations of four data points and (2) sampling four observations and then adding on
more observations until the estimation becomes non-singular, which also assures non-singularity
but leads to fitting lines with non-zero degrees of freedom (R-squared < 1). Applying these
methods do not change the results.

12

REFERENCES
Ball, R., Kothari, S.P., Nikolaev, V.V., 2013. On estimating conditional conservatism. The
Accounting Review 88 (3): 755-787.
Basu. S., 1997. The conservatism principle and the asymmetric timeliness of earnings. Journal of
Accounting and Economics 24 (1): 3-37.
Dietrich, J.R., Muller III, K.A., Riedl, E.J., 2007. Asymmetric timeliness tests of accounting
conservatism. Review of Accounting Studies 12 (1): 95-124.
Givoly, D., Hayn, C.K., Natarajan, A., 2007. Measuring reporting conservatism. The Accounting
Review 82 (1): 65-106.
Leone, A.J., Minutti-Meza, M., Wasley, C., 2014. Influential observations and inference in
accounting research. Working paper.
Ohlson, J.A., Kim, S., 2015. Linear valuation without OLS: The Theil-Sen estimation approach.
Review of Accounting Studies 20 (1): 395-435.
Patatoukas, P.N., Thomas, J.K., 2011. More evidence of bias in the differential timeliness
measure of conditional conservatism. The Accounting Review 86 (5): 1765-1793.
Peng, H., Wang, S., Wang, X., 2008. Consistency and asymptotic distribution of the Theil-Sen
estimator. Journal of Statistical Planning and Inference 138 (6): 1836-1850.
Sen, P.K., 1968. Estimates of the regression coefficient based on Kendalls tau. Journal of the
American Statistical Association 63 (324): 1379-1389.
Theil, H., 1950. A rank-invariant method of linear and polynomial regression analysis.
Nederlandse Akademie Wetenchappen Series A 53: 386-392.
Wilcox, R.R., 2010. Fundamentals of modern statistical methods: Substantially improving power
and accuracy, 2nd Edition. New York: Springer.

13

Table I. Comparison of Basu coefficient estimates: TS vs.OLS

obs.
% bad
1398
35%
2001
1390
76%
2002
1397
7%
2003
1483
33%
2004
1476
27%
2005
1469
33%
2006
1477
66%
2007
1475
88%
2008
1480
11%
2009
1482
20%
2010
median
standard deviation
range: |max min|

bad
0.11
0.11
0.19
0.11
0.12
0.10
0.09
0.09
0.09
0.21
0.11
0.04
0.12

TS
good
0.03
0.01
0.01
0.03
0.00
0.02
0.01
0.02
0.01
0.02
0.01
0.01
0.03

bad-good
0.09
0.10
0.19
0.08
0.12
0.07
0.08
0.07
0.08
0.19
0.08
0.05
0.12

bad
0.18
0.23
0.28
0.32
0.33
0.16
0.22
0.36
0.49
0.48
0.30
0.11
0.32

scaled OLS
good
bad-good
0.02
0.16
-0.01
0.24
-0.05
0.33
0.01
0.31
0.01
0.32
-0.01
0.17
0.00
0.21
-0.01
0.37
-0.05
0.53
0.00
0.48
0.00
0.31
0.02
0.12
0.08
0.37

bad
0.15
0.15
0.11
0.13
0.51
0.02
0.15
0.12
0.15
0.08
0.14
0.13
0.50

unscaled OLS
good
bad-good
0.05
0.09
-0.06
0.21
0.02
0.09
0.12
0.02
0.02
0.50
0.04
-0.02
0.01
0.14
0.03
0.10
0.01
0.13
-0.09
0.17
0.02
0.12
0.06
0.14
0.21
0.52

The table presents annual estimates of coefficient b1 for the following models:
Scaled model: EPSt / Pricet-1 = b0 + b1 Returnt + noiset
Unscaled model: EPSt = b0 Pricet-1 + b1 [Pricet + Dividendst Pricet-1] + noiset
Each year the models are estimated for bad news and good news firms separately. The coefficient estimate for bad (good) news firms
are reported under the bad (good) column. The bad news coefficient minus the good news coefficient, which is equivalent to the
Basu coefficient, is reported under the bad-good column.

14

Table II. Goodness-of-fit

Panel A: Relative accuracy scores
relative accuracy score
2001
2002
2003
2004
2005
2006
2007
2008
2009
2010

TS vs. scaled OLS

60.0%
60.4%
62.1%
56.9%
55.1%
55.4%
60.9%
71.5%
63.6%
54.9%

TS vs. unscaled OLS

55.1%
57.0%
56.1%
59.9%
64.2%
59.6%
57.4%
56.9%
52.1%
66.9%

Based on a binomial distribution with p=0.5, the relative accuracy scores are significant at the
1% level (two-tailed) if the values are outside [48.4%, 51.6%] for yearly statistics.

Panel B: Median absolute percentage errors

2001
2002
2003
2004
2005
2006
2007
2008
2009
2010

TS
2.44
2.59
1.80
1.59
1.48
1.55
1.97
4.41
2.41
1.87

median absolute percentage error

scaled OLS
3.37
3.61
2.58
1.89
1.65
1.64
2.65
9.75
4.02
1.93

unscaled OLS
2.48
2.96
1.91
2.06
2.19
2.00
2.21
5.52
2.45
3.17

Median absolute percentage errors are the yearly median of the absolute difference between the
actual value minus the fitted value scaled by [Pricet/Pricet-1] for the scaled specification and
Pricet for the unscaled specification.

15

Table III. OLS with winsorization

2001
2002
2003
2004
2005
2006
2007
2008
2009
2010
median
standard deviation
range: |max min|

winsorized scaled OLS

bad
good
bad-good
0.12
0.02
0.09
0.20
0.06
0.14
0.28
-0.03
0.30
0.15
0.04
0.11
0.25
0.04
0.21
0.18
0.02
0.16
0.23
0.01
0.22
0.31
0.04
0.26
0.30
0.02
0.28
0.32
0.03
0.29
0.24
0.03
0.21
0.09
0.03
0.11
0.24
0.10
0.28

winsorized unscaled OLS

bad
good
bad-good
0.10
0.04
0.06
0.14
0.07
0.06
0.21
0.03
0.18
0.11
0.04
0.07
0.14
0.05
0.09
0.12
0.04
0.08
0.20
0.02
0.17
0.14
0.05
0.09
0.24
0.04
0.21
0.14
0.02
0.12
0.14
0.04
0.09
0.06
0.01
0.07
0.20
0.03
0.22

The table presents annual estimates of coefficient b1 for the following models:
Scaled model: EPSt / Pricet-1 = b0 + b1 Returnt + noiset
Unscaled model: EPSt = b0 Pricet-1 + b1 [Pricet + Dividendst Pricet-1] + noiset
Each year the models are estimated for bad news and good news firms separately. The
coefficient estimate for bad (good) news firms are reported under the bad (good) column.
The bad news coefficient minus the good news coefficient, which is equivalent to the Basu
coefficient, is reported under the bad-good column.

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Table IV. Piecewise vs. simple linear model

Panel A: Comparisons between piecewise vs. simple linear model

2001
2002
2003
2004
2005
2006
2007
2008
2009
2010

TS
piecewise vs. simple linear
53.1%
51.7%
53.5%
53.3%
55.8%
53.7%
53.7%
51.3%
52.4%
51.1%

relative accuracy score

scaled OLS
piecewise vs. simple linear
63.6%
52.8%
61.3%
54.8%
58.7%
52.7%
54.0%
54.3%
67.7%
56.7%

unscaled OLS
piecewise vs. simple linear
57.5%
48.4%
52.7%
52.7%
63.7%
48.3%
48.7%
52.7%
52.2%
77.5%

Based on a binomial distribution with p=0.5, the relative accuracy scores are significant at the
1% level (two-tailed) if the values are outside [48.4%, 51.6%] for yearly statistics.

Panel B: Median absolute percentage errors of the simple linear model

2001
2002
2003
2004
2005
2006
2007
2008
2009
2010

TS
2.49
2.64
1.78
1.61
1.57
1.58
2.08
4.37
2.44
1.88

median absolute percentage error

scaled OLS
3.67
4.19
2.62
2.26
2.01
1.69
2.97
12.06
4.26
2.29

unscaled OLS
2.77
2.98
1.91
2.10
2.41
2.05
2.11
5.41
2.46
4.01

Median absolute percentage errors are the yearly median of the absolute difference between the
actual value minus the fitted value scaled by [Pricet/Pricet-1] for the scaled specification and
Pricet for the unscaled specification. denotes median absolute percentage errors smaller than the
constrained model.

17

Figure I. Scatter plot and fitted TS and scaled OLS slopes

a. Year 2005

b. Year 2006

18

c. Year 2010

19

Figure II. Time-series variation of Basu coefficients by estimation method

0.6
0.5
0.4
0.3
0.2
0.1
0
1994

1996

1998

2000

Scaled OLS

2002

2004

2006

Scaled OLS, winsorized

2008

2010

2012

TS

The Y-axis is the Basu coefficient and the X-axis is year. Scaled OLS estimates are in the light
blue, solid line; scaled OLS estimates based on winsorized data are in the dark blue, dotted line;
and TS estimates are in the red, double line.

20