The role of diversification in the pricing of accruals quality

The role of diversification in the pricing of accruals quality 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, diversification has little impact on the association between (ambiguous) discretionary accruals quality and cost of capital. http://www.deepdyve.com/assets/images/DeepDyve-Logo-lg.png Review of Accounting Studies Springer Journals

The role of diversification in the pricing of accruals quality

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Publisher
Springer Journals
Copyright
Copyright © 2015 by Springer Science+Business Media New York
Subject
Economics / Management Science; Accounting/Auditing; Finance/Investment/Banking; Public Finance & Economics
ISSN
1380-6653
eISSN
1573-7136
D.O.I.
10.1007/s11142-015-9331-1
Publisher site
See Article on Publisher Site

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, diversification has little impact on the association between (ambiguous) discretionary accruals quality and cost of capital.

Journal

Review of Accounting StudiesSpringer Journals

Published: Jul 16, 2015

References

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