Direct and Mediated Associations among Earnings Quality, Information Asymmetry, and the Cost of Equity

By Nilabhra Bhattacharya, Frank Ecker, Per Olsson, Katherine Schipper. 2012

358 citations recorded by the source corpus.

ABSTRACT: Using path analysis, we investigate the direct and indirect links between three measures of earnings quality and the cost of equity. Our investigation is motivated by analytical models that specify both a direct link and an indirect link that is mediated by information asymmetry, but do not suggest which link would be more important empirically. We measure information asymmetry as both the adverse selection component of the bid-ask spread and the probability of informed trading (PIN). For a large sample of Value Line firms during 1993–2005, we find statistically reliable evidence of both a direct path from earnings quality to the cost of equity, and an indirect path that is mediated by information asymmetry, with the weight of the evidence favoring the direct path as the more important.

Subfields: Accounting, Finance

View Paper: https://www.semanticscholar.org/paper/ebf0db7cd0f92ff714a93f9aedc616f0d767f9c5

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Citations in the corpus

Customer Concentration Risk and the Cost of Equity Capital (2016, background): “While studies find that business risks stemming from a firm’s operating environment and business model tend to have a larger impact than managerial discretion on a firm’s cost of equity (Bhattacharya et al., 2012; Francis et al., 2005), they do not identify the sources of such business risks.”
Financial Statement Comparability and Expected Crash Risk (2016, positive): “…to proxy for the quality of a firm's information environment, consistent with prior studies (e.g., Brown et al., 2004, 2009; Akins et al., 2012; Bhattacharya et al., 2012).16 A high PIN score indicates a low-quality information environment.17 We rank firm–year observations into terciles…”
The effect of information quality on liquidity risk (2011, background): “(2007), and Bhattacharya et al. (2007), who find a negative association between accrual quality (my measure of Reliability) and market risk.”
The Economics of Disclosure and Financial Reporting Regulation: Evidence and Suggestions for Future Research (2015, methodology): “Using path analysis, Bhattacharya et al. (2012) find associations consistent with a direct path from earnings quality to the cost of equity, and an indirect path that is mediated by information asymmetry.”
Influence of National Culture on Accounting Conservatism and Risk Taking in the Banking Industry (2014, neutral): “Following Bhattacharya et al. (2012), we also include other variables (SIZE1, REVG, EQTY, and TOOBIG) in equation (2) as source variables that are posited to have a direct path to risk taking and, therefore, to act like control variables in a regression.”
R2 and Idiosyncratic Risk are not Interchangeable (2014, background): “Bhattacharya, Desai, and Venkataraman (2012) and Bhattacharya, Ecker, Olsson, and Schipper (2012) document that poor earnings quality, proxied by the Dechow-Dichev residuals, is associated with higher adverse selection risk, greater bid-ask spreads, and greater PIN scores.”