Can Improving The Quality Of Accounting Information Reduce Systematic Risk

The Chinese capital market,the largest emerging capital market,which is characterized by imperfect market system and imperfect market environment.The stock market has high risk characteristics such as large fluctuations in stock prices and large market fluctuations.Stock prices are greatly affected by market changes,especially policy changes,with strong co-directional volatility,and the system risk faced by individual stocks accounts for a large proportion of the total risk.System risk is characterized by non-distributability and non-eliminability,which will bring huge losses to investors and the listed companies.However,when the system risk occurs,the degree of stock price reduction of listed companies is different.If the system risk occurs,the recovery speed and degree of stock price are quite different,which indicates the large difference of the ability of individual listed companies to deal with systematic risk.Therefore,it is necessary and urgent to study the characteristics,which lead to the large difference of the ability.It will be benefit for formulating effective countermeasures,implementing risk prevention and supervising for investors.The factors affecting listed companies’ ability to cope with systemic risks are macro-level factors,and the differences between market participants and listed companies themselves.Factors such as the size of the listed company,the ability to pay debts,the efficiency of investment,the state of operation,the state of future development,the return of cash flow and the distribution of dividends,and the number of years of listed companies will all affect the degree of risk resistance to the capital market system.And all of these information of listed companies are from the financial reporting,which indicates that the quality of the financial report will be an important guarantee for the listed company to effectively deal with the systematic risk.To conduct this analysis,we construct a dataset of 20071 firm-year observations from the A share stock market in China for the period 2003-2017.Then further test whether there is a reverse causality between the two construct.We compute two widely used measures of accounting information quality,the Jones model and the modified Jones model,which is the most commonly used in Chinese capital market.We compute the absolute value of residuals as the abnormal accruals in each of security industry groups,in which there are at least 10 firms in a year,which is an indication of poor accounting information quality.It’s intuitive if the abnormal accruals multiplied by minus 1,the larger,the higher the quality of accounting information.Decomposing the total risk into systematic and idiosyncratic risk using the market model regression,we therefore use the product of beta squared and the variance of market returns as a measure of systematic risk.It is equivalent to define the beta as the systematic risk due to the variance of the market return is constant every year.we estimate the relation between accounting information quality and systematic risk using OLS regressions,which is refer to the classic literature.In order to solve the reverse causality,the main explanatory variables(i.e.,Accounting information quality,Size,MB,and ROA)are measured at the ending of the last year.The results clearly indicate that high accounting information quality is associated with low systematic risk.we further address the concern that time-series correlations or common time trends in accounting information quality and systematic risk might account for the observed patterns in the pooled data by estimating Fama-MacBeth regressions.we examine the causal relation between the two constructs using the enactment of the Basic Standards of Internal Control of Enterprises as a pseudo-natural experiment.A number of papers find that accounting information quality has improved since the enactment of the Basic Standards of Internal Control of Enterprises.Thus,if high accounting information quality can decrease systematic risk,we expect firms with poorer accounting information quality in the pre-period to exhibit a greater reduction in this risk in the post-period.The findings are consistent with the notion that higher accounting information quality causes systematic risk to decrease.Up to this point,we have relied on risk measures that stem from parameterized factor models.Although these models provide the conventional approach to measure firm risk,a frequently voiced concern regarding these models is that they might be incomplete in identifying risk factors.In light of this potential bad-model problem in measuring risk,we follow Lakonishok et al.(1994)and adopt an alternative,nonparametric approach in identifying fundamentally risky firms.Lakonishok et al.(1994)argue that for firms to be fundamentally risky for any reason,they must underperform other firms in the states of the world when the marginal utility of wealth and the price of risk are high.They further suggest that performance in extreme bad states indicates how risky a firm is,"even when conventional measures of risk such as beta and standard deviation do not show it".Following this idea,we classify the bottom(top)30%of sample firms with the lowest(highest)annual returns in each of the stock market’s worst years from 2003 to 2017 as high-risk(low-risk)firms.The worst years for the stock market are defined that the annual returns of Shanghai Composite Index which can well reflect the operation of Chinese stock market are negative.The dependent variable is a dummy variable(Bottom)that equals one for bottom firms and zero for others.Given the dichotomous nature of the dependent variable,we estimate the regressions through probit and logit.The results suggest that the negative relation between high accounting information quality and systematic risk is robust to a model-free risk.In the robustness test,we use the leverage-adjusted beta to measure systematic risk,and re-estimate beta value using daily return data in each year.Meanwhile,analyst forecast consensus,analyst coverage,analyst report attention,information Opacity and the information disclosure level of shen-zhen stock exchange are selected as alternative measures of accounting information quality.we find that the results are highly consistent with those based on accruals quality.First,our paper provides new insights into the mechanisms through which accounting information quality affects the cost of capital.In particular,we provide empirical evidence in support of the idea that it is plausible for accounting information quality to affect the cost of capital through a link with firm beta.Second,our study also contributes to a large literature on the relation between financial reporting and firm risk,arguably one of the most fundamental issues in accounting and finance.This literature provides fairly clear evidence of a negative relation between financial reporting and idiosyncratic risk.Third,our paper is related to a growing number of empirical studies that investigate the impact of firm-specific events on systematic risk.We add to this line of research by focusing on an important aspect of a major and regular firm-specific event,that is,the quality of the firm’s financial reporting.At last,further analysis indicates that improving accounting information quality causes systematic risk to decrease.These findings have important implications for disclosure decisions,portfolio management,and asset pricing.