Does Information Risk Really Matter? An Analysis of the Determinants and Economic Consequences of Financial Reporting Quality
58 Pages Posted: 21 Apr 2006
Date Written: January 23, 2006
I investigate the determinants and economic consequences associated with financial reporting quality. I find evidence of a positive association between investors' demands for firm-specific information and financial reporting quality. In addition, the evidence suggests that higher proprietary costs (proxied by capital intensity, product market competition, and growth opportunities) are associated with a lower quality of financial information. Controlling for the firm-specific characteristics determining financial reporting quality, I find evidence of a negative association between firms' total risk and financial reporting quality. Decomposing total risk into a systematic component and an idiosyncratic one, the results imply that firms providing financial information of higher quality do not necessarily enjoy a lower cost of equity capital. However, a significant negative relation is documented between reporting quality and idiosyncratic risk. This suggests that the quality of accounting information cannot be characterized as an additional systematic priced risk factor, but rather as an idiosyncratic one, once the firm-specific characteristics determining information quality are controlled for. These results demonstrate the importance of explicitly controlling for the determinants of financial reporting quality when investigating the associated economic consequences and question recent empirical evidence on the association between reporting quality and the cost of equity capital.
Keywords: Financial reporting quality, Earnings quality, cost of capital, systematic risk, idiosyncratic risk
JEL Classification: G12, M41, M43
Suggested Citation: Suggested Citation