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

Yaniv KONCHITCHKI; Yan LUO; Mary L. Z. MA; Feng WU

doi:10.1007/s11142-015-9338-7

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

Yaniv KONCHITCHKI, Yan LUO, Mary L. Z. MA, Feng WU

Research output: Journal Publications › Journal Article (refereed) › peer-review

41 Citations (Scopus)

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.

Original language	English
Pages (from-to)	1-36
Number of pages	36
Journal	Review of Accounting Studies
Volume	21
Issue number	1
Early online date	29 Aug 2015
DOIs	https://doi.org/10.1007/s11142-015-9338-7
Publication status	Published - Mar 2016
Externally published	Yes

Bibliographical note

We appreciate helpful comments and suggestions from Yakov Amihud, Mary Barth, Sunil Dutta, Peter Easton, Jennifer Huang, Scott Joslin, Henry Laurion, Alastair Lawrence, Laura Liu, Gustavo Manso, Alexander Nezlobin, Topseht Nonam, Jim Ohlson, Panos Patatoukas, Andy Rose, Richard Sloan, Steve Tadelis, Vicki Tang, Rodrigo Verdi, Annika Wang, Joanna Wu, Hong Xie, Jenny Zha, Weining Zhang, Yong Zhang, three anonymous referees, and seminar participants at University of California at Berkeley’s Haas School of Business, Cheung Kong Graduate School of Business, Dalhousie University, Memorial University of Newfoundland, York University, and Canadian Academic Accounting Association Student/Junior Faculty Workshop.

Funding

Yaniv Konchitchki acknowledges financial support from Berkeley’s Hellman Fellows Research Excellence Fund. Yan Luo acknowledges financial support from the National Natural Science Foundation of China (NSFC Project Number 71402032).

Keywords

Accounting performance
Earnings downside risk
Cost of capital
Financial statement analysis
Macroeconomy

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10.1007/s11142-015-9338-7

Cite this

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

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{\textquoteright} 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{\textquoteright} financial statements, also shedding new light on the link between accounting and the macroeconomy.",

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

Abstract

Bibliographical note

Funding

Keywords

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