Skip to main content
SpringerLink
Log in

Accounting information quality and systematic risk

  • Original Research
  • Published:
Review of Quantitative Finance and Accounting Aims and scope Submit manuscript

Abstract

Whether and how accounting information quality affects the cost of capital has been a matter of much debate. We contribute to this debate by linking accounting information quality to systematic risk, inspired by recent theoretical discussions. Using the universe of firms jointly listed in the CRSP and Compustat databases from 1962 to 2012, we find that accounting information quality is significantly and negatively related to systematic risk. This relation is robust to alternative proxies for the two constructs, including a model-free measure of risk. Further analysis indicates that improving accounting information quality causes systematic risk to decrease. These findings have important implications for disclosure decisions, portfolio management, and asset pricing.

This is a preview of subscription content, log in via an institution to check access.

Access this article

Log in via an institution

Subscribe and save

Springer+ Basic
$34.99 /Month
  • Get 10 units per month
  • Download Article/Chapter or eBook
  • 1 Unit = 1 Article or 1 Chapter
  • Cancel anytime
Subscribe now

Buy Now

Price excludes VAT (USA)
Tax calculation will be finalised during checkout.

Instant access to the full article PDF.

Institutional subscriptions

Similar content being viewed by others

Notes

  1. Rajgopal and Venkatachalam (2011) choose to use the squared value of abnormal accruals because it is believed to have more desirable distributional properties. However, we find that in our data, the absolute value is more normally distributed than the squared value. Because data transformations can alter the fundamental nature of the data, create curvilinear relationships, and complicate interpretations (Osborne 2002), we prefer to use the absolute value. Another reason that favors the absolute value is that conceptually, the absolute value of abnormal accruals is a more direct measure of earnings quality than the squared value of abnormal accruals. Empirically, the absolute value of abnormal accruals is more widely used than the squared value of abnormal accruals. We note that as in Rajgopal and Venkatachalam (2011), using either the absolute or the squared value produces similar results.

  2. Although Lambert, Leuz, and Verrecchia (2007) and Armstrong, Banerjee, and Corona (2013) suggest that accounting information quality could affect systematic risk, the direction of this impact is ambiguous in their models. This ambiguity, however, is not inconsistent with the notion that accounting information quality is related to systematic risk.

  3. We acknowledge that a negative relation between accounting information quality and systematic risk is not the only view. For example, Johnstone (2016) argues that better information might actually leave investors less certain about future events and thus the relation between accounting information quality and systematic risk might be positive. The discrepancy in theoretical discussions seems to make our empirical analysis even more worthwhile.

  4. While there is a large empirical literature on systematic risk, there are few theoretical models on the determinants of firm betas (for a comprehensive discussion of this issue, see Hong and Sarkar (2007)). In examining systematic risk, previous studies typically control for major firm characteristics. Here we follow Low (2009) and control for this particular set of variables for two reasons. First, these firm-level variables cover the most important firm characteristics that are often used as controls for firm risk. Second, using the same control variables as in Low (2009) makes our results easily comparable. This comparability is desirable given that there is not a fixed set of control variables that is widely agreed upon by researchers.

  5. For the same period (i.e., 1962–2001), our sample appears to be very comparable to that of Rajgopal and Venkatachalam (2011). For example, the DD measure is available for 95,270 firm-year observations in their sample and 95,461 in ours. Our average DD measure of information quality is 4.43, with a standard deviation of 4.46; theirs are 4.47 and 4.15 respectively. Our mean squared value of the ABACC measure is 0.75, with a standard deviation of 1.95; theirs are 0.91 and 2.39 respectively.

  6. This statistic is based on the mean value of the market-model systematic risk measure in Table 1.

  7. Note that the rank risk measures are ranks (from 100 to 1) of firms based on their raw risk measures in a single year. Thus, the rank measures do not vary with market volatility. In essence, the rank measures compare the absolute value of firm betas in a single year.

  8. We believe that a 3-year window is long enough for the effects of an event to materialize but also short enough to mitigate the effects of confounding factors. Using a 1-year or 2-year window yields similar results.

  9. Over 50 years from 1962 to 2012, S&P 500 has negative returns in only 12 years. The returns in the ten worst years range from − 6.98% (in 1977) to − 36.55% (in 2008). The other two negative returns are − 4.7% (in 1981) and − 3.06% (in 1990). We note that using the ten worst years for the CRSP equally-weighted portfolio in the sample period produces virtually the same results.

  10. It is possible that the worst-time performance of stocks (especially individual ones) might reflect both systematic and idiosyncratic risk factors. One way to alleviate this concern is to identify the states of the world that are truly reflective of the states of the market instead of those of the individual firms in a sample. In addition, one can use a large sample so that the idiosyncratic components of firm performance would matter less when firm performance is averaged out. We have taken both steps in the study.

References

  • Armstrong CS, Balakrishnan K, Cohen D (2012) Corporate governance and the information environment: evidence from state antitakeover laws. J Account Econ 53:185–204

    Article  Google Scholar 

  • Armstrong CS, Banerjee S, Corona C (2013) Factor-loading uncertainty and expected returns. Rev Financ Stud 26:158–207

    Article  Google Scholar 

  • Ashbaugh-Skaife H, Collins DW, Kinney WR Jr, Lafond R (2009) The effect of SOX internal control deficiencies on firm risk and cost of equity. J Account Res 47:1–43

    Article  Google Scholar 

  • Babenko I, Boguth O, Tserlukevich Y (2016) Idiosyncratic cash flows and systematic risk. J Finance 71:425–456

    Article  Google Scholar 

  • Bandyopadhyay SP, Huang AG, Sun KJ, Wirjanto TS (2017) The return premiums to accruals quality. Rev Quant Finance Account 48:83–115

    Article  Google Scholar 

  • Bartram SM, Brown GW, Conrad J (2011) The effects of derivatives on firm risk and value. J Financ Quant Anal 46:967–999

    Article  Google Scholar 

  • Beyer A, Cohen DA, Lys TZ, Walther BR (2010) The financial reporting environment: review of the recent literature. J Account Econ 50:296–343

    Article  Google Scholar 

  • Brown S (1979) The effect of estimation risk on capital market equilibrium. J Financ Quant Anal 14:215–220

    Article  Google Scholar 

  • Cai CX, Faff RW, Hillier D, Mohamed S (2007) Exploring the link between information quality and systematic risk. J Financ Res 30:335–353

    Article  Google Scholar 

  • Chen C, Huang AG, Jha R (2012) Idiosyncratic return volatility and the information quality underlying managerial discretion. J Financ Quant Anal 47:873–899

    Article  Google Scholar 

  • Cheynel E (2013) A theory of voluntary disclosure and cost of capital. Rev Account Stud 18:987–1020

    Article  Google Scholar 

  • Core JE, Guay WR, Verdi R (2008) Is accruals quality a priced risk factor? J Account Econ 46:2–22

    Article  Google Scholar 

  • Core JE, Hail L, Verdi RS (2015) Mandatory disclosure quality, inside ownership, and cost of capital. Eur Account Rev 24:1–29

    Article  Google Scholar 

  • Dechow PM, Dichev ID (2002) The quality of accruals and earnings: the role of accrual estimation errors. Account Rev 77:35–59

    Article  Google Scholar 

  • Denis DJ, Kadlec GB (1994) Corporate events, trading activity, and the estimation of systematic risk: evidence from equity offerings and share repurchases. J Finance 49:1787–1811

    Article  Google Scholar 

  • Dichev ID, Tang VW (2009) Earnings volatility and earnings predictability. J Account Econ 47:160–181

    Article  Google Scholar 

  • Dyck A, Morse A, Zingales L (2010) Who blows the whistle on corporate fraud? J Finance 65:2213–2253

    Article  Google Scholar 

  • Easley D, O’hara M (2004) Information and the cost of capital. J Finance 59:1553–1583

    Article  Google Scholar 

  • Fama EF (1998) Market efficiency, long-term returns, and behavioral finance. J Financ Econ 49:283–306

    Article  Google Scholar 

  • Fama EF, French KR (1993) Common risk factors in the returns on stocks and bonds. J Financ Econ 33:3–56

    Article  Google Scholar 

  • Fama EF, French KR (1997) Industry costs of equity. J Financ Econ 43:153–193

    Article  Google Scholar 

  • Francis J, LaFond R, Olsson P, Schipper K (2005) The market pricing of accruals quality. J Account Econ 39:295–327

    Article  Google Scholar 

  • Green TC, Hwang B-H (2009) Price-based return comovement. J Financ Econ 93:37–50

    Article  Google Scholar 

  • Hong G, Sarkar S (2007) Equity systematic risk (beta) and its determinants. Contemp Account Res 24:423–466

    Article  Google Scholar 

  • Hughes JS, Liu J, Liu J (2007) Information asymmetry, diversification, and cost of capital. Account Rev 82:705–729

    Article  Google Scholar 

  • Isidro H, Dias JG (2017) Earnings quality and the heterogeneous relation between earnings and stock returns. Rev Quant Finance Account 49:1143–1165

    Article  Google Scholar 

  • Jin L (2002) CEO compensation, diversification, and incentives. J Financ Econ 66:29–63

    Article  Google Scholar 

  • Johnstone D (2016) The effect of information on uncertainty and the cost of capital. Contemp Account Res 33:752–774

    Article  Google Scholar 

  • Jones JJ (1991) Earnings management during import relief investigations. J Account Res 29:193–228

    Article  Google Scholar 

  • Kogan S, Routledge B, Sagi J, Smith N (2009) Information content of public firm disclosures and the Sarbanes-Oxley Act. Working Paper, The University of Texas, Austin

  • Kothari SP, Shu S, Wysocki PD (2009) Do managers withhold bad news? J Account Res 47:241–276

    Article  Google Scholar 

  • Lakonishok J, Shleifer A, Vishny RW (1994) Contrarian investment, extrapolation, and risk. J Finance 49:1541–1578

    Article  Google Scholar 

  • Lambert R, Leuz C, Verrecchia RE (2007) Accounting information, disclosure, and the cost of capital. J Account Res 45:385–420

    Article  Google Scholar 

  • Lang M, Maffett M (2011) Transparency and liquidity uncertainty in crisis periods. J Account Econ 52:101–125

    Article  Google Scholar 

  • Larcker DF, Rusticus TO (2010) On the use of instrumental variables in accounting research. J Account Econ 49:186–205

    Article  Google Scholar 

  • Lintner J (1965) The valuation of risk assets and the selection of risky investments in stock portfolios and capital budgets. Rev Econ Stat 47:13–37

    Article  Google Scholar 

  • Low A (2009) Managerial risk-taking behavior and equity-based compensation. J Financ Econ 92:470–490

    Article  Google Scholar 

  • Marquardt C, Zur E (2014) The role of accounting quality in the M&A market. Manage Sci 61:604–623

    Article  Google Scholar 

  • Mitchell ML, Stafford E (2000) Managerial decisions and long-term stock price performance. J Bus 73:287–329

    Article  Google Scholar 

  • Ng J (2011) The effect of information quality on liquidity risk. J Account Econ 52:126–143

    Article  Google Scholar 

  • Osborne J (2002) Notes on the use of data transformations. Practical Assessment, Research & Evaluation 8, Published online

  • Patton AJ, Verardo M (2012) Does beta move with news? Firm-specific information flows and learning about profitability. Rev Financ Stud 25:2789–2839

    Article  Google Scholar 

  • Rajgopal S, Venkatachalam M (2011) Financial reporting quality and idiosyncratic return volatility. J Account Econ 51:1–20

    Article  Google Scholar 

  • Sadka R (2011) Liquidity risk and accounting information. J Account Econ 52:144–152

    Article  Google Scholar 

  • Savor P, Wilson M (2016) Earnings announcements and systematic risk. J Finance 71:83–138

    Article  Google Scholar 

  • Sharpe WF (1964) Capital asset prices: a theory of market equilibrium under conditions of risk. J Finance 19:425–442

    Google Scholar 

  • Tang VW (2011) Isolating the effect of disclosure on information risk. J Account Econ 52:81–99

    Article  Google Scholar 

  • Veronesi P (2000) How does information quality affect stock returns? J Finance 55:807–837

    Article  Google Scholar 

  • Zhang XF (2006) Information uncertainty and stock returns. J Finance 61:105–137

    Article  Google Scholar 

Download references

Author information

Authors and Affiliations

  1. Department of Accounting and Finance, University of Alabama in Huntsville, Huntsville, AL, USA

    Xuejing Xing

  2. Department of Management, Sigmund Weis School of Business, Susquehanna University, Selinsgrove, PA, USA

    Shan Yan

Authors
  1. Xuejing Xing
    View author publications

    You can also search for this author in PubMed Google Scholar

  2. Shan Yan
    View author publications

    You can also search for this author in PubMed Google Scholar

Corresponding author

Correspondence to Xuejing Xing.

Rights and permissions

Reprints and permissions

About this article

Check for updates. Verify currency and authenticity via CrossMark

Cite this article

Xing, X., Yan, S. Accounting information quality and systematic risk. Rev Quant Finan Acc 52, 85–103 (2019). https://doi.org/10.1007/s11156-018-0703-z

Download citation

  • Published:

  • Issue Date:

  • DOI: https://doi.org/10.1007/s11156-018-0703-z

Keywords

JEL Classification

Search

Navigation