Review of Accounting Studies

, Volume 12, Issue 2–3, pp 325–370

Conservatism, growth, and return on investment

  • Madhav V. Rajan
  • Stefan Reichelstein
  • Mark T. Soliman


Return on Investment (ROI) is widely regarded as a key measure of firm profitability. The accounting literature has long recognized that ROI will generally not reflect economic profitability, as determined by the internal rate of return (IRR) of a firm’s investment projects. In particular, it has been noted that accounting conservatism may result in an upward bias of ROI, relative to the underlying IRR. We examine both theoretically and empirically the behavior of ROI as a function of two variables: past growth in new investments and accounting conservatism. Higher growth is shown to result in lower levels of ROI provided the accounting is conservative, while the opposite is generally true for liberal accounting policies. Conversely, more conservative accounting will increase ROI provided growth in new investments has been “moderate” over the relevant horizon, while the opposite is true if new investments grew at sufficiently high rates. Taken together, we find that conservatism and growth are “substitutes” in their joint impact on ROI.


Return on investment Conservatism Economic profitability 

JEL Classifications

G31 M41 


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Copyright information

© Springer Science+Business Media, LLC 2007

Authors and Affiliations

  • Madhav V. Rajan
    • 1
  • Stefan Reichelstein
    • 1
  • Mark T. Soliman
    • 1
  1. 1.Graduate School of BusinessStanford UniversityStanfordUSA

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