The Effect of Fundamental Risk on the Market Pricing of Accruals Quality

Information risk, stock returns, and asset pricing: Evidence from China

Accounting Research Journal ◽

10.1108/arj-04-2015-0057 ◽

2017 ◽

Vol 30 (4) ◽

pp. 379-394 ◽

Cited By ~ 1

Author(s):

Raheel Safdar ◽

Chen Yan

Keyword(s):

Stock Returns ◽

Factor Model ◽

Empirical Literature ◽

Firm Level ◽

Cross Sectional ◽

Market Pricing ◽

Content Type ◽

Information Risk ◽

Accruals Quality ◽

Three Factor

Purpose This study aims to investigate information risk in relation to stock returns of a firm and whether information risk is priced in China. Design/methodology/approach The authors used accruals quality (AQ) as their measure of information risk and performed Fama-Macbeth regressions to investigate association of AQ with future realized stock returns. Moreover, two-stage cross-sectional regression analysis was performed, both at firm level and at portfolio level, to test if the AQ factor is priced in China in addition to existing factors in the Fama French three-factor model. Findings The authors found poor AQ being associated with higher future realized stock returns. Moreover, they found evidence of market pricing of AQ in addition to existing factors in the Fama French three-factor model. Further, subsample analysis revealed that investors value AQ more in non-state owned enterprises than in state owned enterprises. Research limitations/implications The study sample comprises A-shares only and the generalization of the findings is limited by the peculiar institutional and economic setup in China. Originality/value This study contributes to market-based accounting literature by providing further insight into how and if investors value information risk, and it seeks to fill gap in empirical literature by providing evidence from the Chinese capital market.

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The Effect of Fundamental Risk on the Market Pricing of Accruals Quality

Journal of Accounting Auditing & Finance ◽

10.1177/0148558x0802300403 ◽

2008 ◽

Vol 23 (4) ◽

pp. 471-492 ◽

Cited By ~ 14

Author(s):

Linda H. Chen ◽

Dan S. Dhaliwal ◽

Mark A. Trombley

Keyword(s):

Cost Of Capital ◽

Market Pricing ◽

Implied Cost Of Capital ◽

Accruals Quality ◽

Future Return ◽

Strong Relation ◽

Alternative Measures ◽

The Empirical Analysis ◽

Asset Pricing Tests ◽

Theoretical Results

Motivated by the theoretical results of Yee (2006), we extend the empirical analysis of Francis, LaFond, Olsson, and Schipper (2005) to test the prediction that the effect of accruals quality on cost of capital increases with fundamental risk. In asset pricing tests, we find that there is essentially no relation between accruals quality and cost of capital as measured by future return realizations for firms with the lowest fundamental risk. In contrast, for firms with the highest fundamental risk, there is a strong relation between accruals quality and future return realizations. Using earnings-price ratios and average implied cost of capital as alternative measures of cost of capital, we find that, as fundamental risk increases, accruals quality has an increasing effect on cost of capital and that the effect of accruals quality on cost of capital is reduced for firms with low fundamental risk. Overall, the results in this paper show that that relation depends critically on the level of fundamental risk, consistent with the model of Yee (2006). The results also serve to qualify the findings of Francis et al. (2005), who document a relation between accruals quality and cost of capital.

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