What Affects Factor Loading Uncertainty and Expected Returns? The Role of Accounting Quality

Abstract

Despite considerable research on the association between accounting quality and expected returns, much is yet to be learnt about specific underlying mechanisms. Motivated by recent advancements in theoretical work, this study empirically examines how firm-specific information quality affects expected returns through factor loading uncertainty. We document that the quality of accounting information is negatively associated with factor loading uncertainty, and positively associated with the cross-section of expected returns. More importantly, the impact of accounting quality on stock returns is largely driven by the negative correlation between factor loading uncertainty and expected returns. The findings are robust with respect to alternative measures of accounting quality and various model specifications. Overall, these results improve our understanding of how accounting quality affects stock returns.

Keywords: Accounting quality, cross-section of stock returns, factor loading uncertainty, information asymmetry, asset pricing

JEL Classification: G10, G12, G14, M40