Accounting-based downside risk, cost of capital, and the macroeconomy

Accounting-based downside risk, cost of capital, and the macroeconomy We hypothesize that earnings downside risk, capturing the expectation for future downward operating performance, contains distinct information about firm risk and varies with cost of capital in the cross section of firms. Consistent with the validity of the earnings downside risk measure, we find that, relative to low earnings downside risk firms, high earnings downside risk firms experience more negative operating performance over the subsequent period, are more sensitive to downward macroeconomic states, and are more strongly linked to earnings attributes and other risk-related measures from prior research. In line with our prediction, we also find that earnings downside risk explains variation in firms’ cost of capital, and that this link between earnings downside risk and cost of capital is incremental to several earnings attributes, accounting and risk factor betas, return downside risk, default risk, earnings volatility, and firm fundamentals. Overall, this study contributes to accounting research by demonstrating the key valuation and risk assessment roles of earnings downside risk derived from firms’ financial statements, also shedding new light on the link between accounting and the macroeconomy. http://www.deepdyve.com/assets/images/DeepDyve-Logo-lg.png Review of Accounting Studies Springer Journals

Accounting-based downside risk, cost of capital, and the macroeconomy

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Publisher
Springer Journals
Copyright
Copyright © 2015 by Springer Science+Business Media New York
Subject
Business and Management; Accounting/Auditing; Corporate Finance; Public Finance & Economics
ISSN
1380-6653
eISSN
1573-7136
D.O.I.
10.1007/s11142-015-9338-7
Publisher site
See Article on Publisher Site

Abstract

We hypothesize that earnings downside risk, capturing the expectation for future downward operating performance, contains distinct information about firm risk and varies with cost of capital in the cross section of firms. Consistent with the validity of the earnings downside risk measure, we find that, relative to low earnings downside risk firms, high earnings downside risk firms experience more negative operating performance over the subsequent period, are more sensitive to downward macroeconomic states, and are more strongly linked to earnings attributes and other risk-related measures from prior research. In line with our prediction, we also find that earnings downside risk explains variation in firms’ cost of capital, and that this link between earnings downside risk and cost of capital is incremental to several earnings attributes, accounting and risk factor betas, return downside risk, default risk, earnings volatility, and firm fundamentals. Overall, this study contributes to accounting research by demonstrating the key valuation and risk assessment roles of earnings downside risk derived from firms’ financial statements, also shedding new light on the link between accounting and the macroeconomy.

Journal

Review of Accounting StudiesSpringer Journals

Published: Aug 29, 2015

References

  • Earnings quality, insider trading, and cost of capital
    Aboody, D; Hughes, J; Liu, J
  • Discretionary accounting choices and the predictive ability of accruals with respect to future cash flows
    Badertscher, AB; Collins, DW; Lys, TZ
  • Risks for the long run: A potential resolution of asset pricing puzzles
    Bansal, R; Yaron, A
  • Cost of capital and earnings transparency
    Barth, ME; Konchitchki, Y; Landsman, WR
  • The conservatism principle and the asymmetric timeliness of earnings
    Basu, S

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