Information Risk and the Cost of Equity Capital Revisited: Evidence from the U.S. Property-Casualty Insurance Industry

56 Pages Posted: 2 Oct 2017 Last revised: 2 May 2018

See all articles by Hua Chen

Hua Chen

University of Hawaiʻi at Mānoa

Yingrui Lu

Temple University - Department of Risk, Insurance and Healthcare Management

Mary A. Weiss

Temple University

Date Written: September 29, 2017

Abstract

This paper revisits the relationship between information risk and the cost of equity capital in the U.S. property-casualty (P/C) insurance industry. Eckles, Halek and Zhang (2014) find that information risk has no effect on the cost of equity using a sample of U.S. P/C insurers. Following their approach, we decompose information risk into innate and discretionary components. We find that innate information risk affects the cost of equity capital through two opposing channels. On the one hand, innate information risk directly increases an insurer’s cost of equity capital by increasing investors’ assessment of the riskiness of the insurer’s future cash flows. On the other hand, innate information risk indirectly decreases the insurer’s cost of equity capital by changing its production so that the assessed riskiness of the firm’s future cash flows are reduced. This (negative) indirect effect depends on factors that influence the insurer’s underwriting decisions. Our empirical results provide supporting evidence for a significant, positive direct effect of innate information risk, while the magnitude of the (negative) indirect effect increases with the insurer’s proportion of long-tail business and decreases with its affiliated reinsurance usage. As to the impact of discretionary information risk, our results are mixed. We also find that, on average, the overall effect of information risk on the cost of equity capital for property-casualty insurers is significant and negative.

Keywords: Cost of Equity Capital, Information Risk, Accruals Quality

Suggested Citation

Chen, Hua and Lu, Yingrui (Elaine) and Weiss, Mary A., Information Risk and the Cost of Equity Capital Revisited: Evidence from the U.S. Property-Casualty Insurance Industry (September 29, 2017). Fox School of Business Research Paper No. 17-034. Available at SSRN: https://ssrn.com/abstract=3045472 or http://dx.doi.org/10.2139/ssrn.3045472

Hua Chen (Contact Author)

University of Hawaiʻi at Mānoa ( email )

2404 Maile Way, E-602e
Honolulu, HI 96822
United States
(808) 956-8063 (Phone)
(808) 956-9887 (Fax)

Yingrui (Elaine) Lu

Temple University - Department of Risk, Insurance and Healthcare Management ( email )

Fox School of Business and Management
1801 Liacouras Walk
Philadelphia, PA 19122
United States

Mary A. Weiss

Temple University ( email )

Fox School of Business and Management
1801 Liacouras Walk
Philadelphia, PA 19122
United States
215-204-1916 (Phone)

HOME PAGE: http://www.sbm.temple.edu/~rmidept/weiss.html

Register to save articles to
your library

Register

Paper statistics

Downloads
80
Abstract Views
419
rank
301,447
PlumX Metrics