The role of diversiﬁcation in the pricing of accruals
Published online: 16 July 2015
Ó Springer Science+Business Media New York 2015
Abstract Prior studies suggest that accounting information risk, primarily
idiosyncratic in nature, can be diversiﬁed away. I show that accounting information
risk, proxied by accruals quality, is priced even if it is entirely idiosyncratic.
Building on a model developed in the ambiguity literature, I predict that, (1) in an
under-diversiﬁed market, idiosyncratic information risk is priced even if it is
diversiﬁable, and (2) in a well-diversiﬁed market, idiosyncratic information risk is
priced when information is subject to managers’ discretion and thus ambiguous. The
empirical results corroborate the predictions from the model. An association is
observed between (unambiguous if risky) innate accruals quality and cost of capital.
This association can be largely mitigated through diversiﬁcation. However, diver-
siﬁcation has little impact on the association between (ambiguous) discretionary
accruals quality and cost of capital.
Keywords Accruals quality Á Cost of capital Á Diversiﬁcation Á Ambiguity
JEL Classiﬁcation M4 Á G12 Á G14
A fundamental question in accounting research is whether accounting information
risk (or quality) is priced in the capital market. Prior studies have theoretically and
empirically shown a link between information risk and cost of capital (e.g., Easley
& Yu Hou
Queen’s School of Business, Queen’s University, Kingston, ON, Canada
Rev Account Stud (2015) 20:1059–1092