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

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  • Yaniv Konchitchki

    () (University of California at Berkeley)

  • Yan Luo

    (Fudan University)

  • Mary L. Z. Ma

    (York University)

  • Feng Wu

    (The Hong Kong Polytechnic University)

Abstract

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.

Suggested Citation

  • Yaniv Konchitchki & Yan Luo & Mary L. Z. Ma & Feng Wu, 2016. "Accounting-based downside risk, cost of capital, and the macroeconomy," Review of Accounting Studies, Springer, vol. 21(1), pages 1-36, March.
  • Handle: RePEc:spr:reaccs:v:21:y:2016:i:1:d:10.1007_s11142-015-9338-7
    DOI: 10.1007/s11142-015-9338-7
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    Keywords

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

    JEL classification:

    • M41 - Business Administration and Business Economics; Marketing; Accounting; Personnel Economics - - Accounting - - - Accounting
    • G12 - Financial Economics - - General Financial Markets - - - Asset Pricing; Trading Volume; Bond Interest Rates
    • G14 - Financial Economics - - General Financial Markets - - - Information and Market Efficiency; Event Studies; Insider Trading

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