Stock

THE ACCOUNTING REVIEW Vol. 85, No. 3 2010 pp. 937–978

American Accounting Association DOI: 10.2308/accr.2010.85.3.937

Accruals Quality, Stock Returns, and Macroeconomic Conditions

Dongcheol Kim Korea University Yaxuan Qi Concordia University

ABSTRACT: This study examines whether and how earnings quality, measured as accruals quality AQ , affects the cost of equity capital. Using two-stage cross-sectional regression tests, we find that the AQ risk factor is significantly priced, after controlling for low-priced stocks. This result is robust in tests using individual stocks, various portfolio formations, and different beta estimations. Furthermore, we show that AQ and its pricing effect systematically vary with business cycles and macroeconomic variables. In particular, this pricing effect is prominent in total AQ and innate AQ but not in discretionary AQ. The risk premium associated with AQ exists only in economic expansion but not in recession periods. Poorer AQ firms are more vulnerable to macroeconomic shocks. The risk premium and the dispersion of AQ are also related to future economic activity. Overall, our results suggest that AQ contributes to the cost of equity capital and that its pricing effect is associated with fundamental risk. Keywords: accruals quality; risk factor models; cross-sectional regression tests; macroeconomic conditions; low-priced returns. JEL Classifications: G12; G14.

I. INTRODUCTION he extent to which earnings quality, and more broadly information quality, is associated with the cost of capital is one of the most important issues in accounting. Despite a sizeable body of research suggesting that earnings quality, measured using various attributes, affects costs of debt and equity capital Botosan 1997; Botosan and Plumlee 2002; Francis et al. 2004, 2005; Aboody et al. 2005 , there is no consensus on whether earnings quality is priced in the cost

T

We thank Frank Ecker, Andrei Jirnyi, Deborah Lucas, Gregory Lypny, Per Olsson,...