An International Meeting of the American Accounting Association American Accounting Association 2006 Annual Meeting August 6–9, 2006 Washington, D.C.

D. Craig Nichols
Cornell University

Abstract: I analyze portfolio rankings and factor returns of the earnings quality factor (EQF), introduced by recent research, to assess whether EQF is a fundamental or information risk factor. I find that EQF portfolio rankings do not positively correlate with the probability of informed trade, a characteristic that prior research links to information risk. However, EQF rankings strongly correlate with the systematic component of firm-level cash flows. Moreover, EQF factor returns relate to news about future macroeconomic variables, such as GDP growth, inflation, and interest rates. Traditional theories of fundamental risk predict that risk factors will relate to macro variables, while extant theories of information risk do not make this prediction. Thus, the evidence in this paper suggests that EQF captures a dimension of fundamental risk, and researchers should use caution in interpreting EQF factor loadings as measures of earnings quality or exposure to information risk.

Back to Session Listing

AAA Home Page