Stock Price and Risk Related to Accounting Changes in Inventory Valuation.

Abstract During an inflationary period, changes to the last in, first out (LIFO) method of inventory valuation generally result in reduction of reported earnings and in deferment of tax payments. If the investors rely on the reported earnings, the stock price of the firms which change to the LIFO method will decrease and if they rely on the economic value of the firms, the stock price will increase. Several studies of the relationship between accounting changes and stock price behavior have been conducted by using a research design, as of April 1975. The design involves the use of the market model to isolate the stock price changes associated with specific events from the market-wide price changes. The article attempts to measure the association between the accounting and price changes by abstracting the effect of risk changes. This is accomplished by estimating the time path of the relative risk of stocks during the months surrounding the date of accounting change. The problem of estimating the relative risk of stocks when it is not constant is considered in another section of the article. Conclusions of the study about the relationship between stock price behavior and accounting changes are presented in the last section.