Information risk, stock returns, and the cost of capital in China

Abstract

Purpose

The purpose of this paper is to investigate information risk in relation to cost of capital and, also, whether information risk is a priced risk factor in China.

Design/methodology/approach

The authors used accruals quality (AQ) as the measure of information risk and employed multiple regression analysis and Fama-Macbeth regressions to investigate association of AQ with cost of capital and future realized stock returns, respectively. Moreover, two-stage cross-sectional regression analysis is performed, both at firm and at portfolio levels, to test if an AQ factor is a priced risk factor in China.

Findings

The authors found poor AQ being associated with higher cost of equity but this relationship is not significant in subsample of state-owned enterprises (SOEs). The results do not support any association between AQ and cost of debt in China. Further, the authors found poor AQ being positively associated with future realized stock returns and the authors also found evidence of market pricing of an AQ factor in addition to existing factors in Fama-French three-factor model in firm level analysis. However, subsample analysis revealed that AQ is not priced in case of SOEs.

Research limitations/implications

The study sample is comprised of A-Shares only and the generalization of the findings is limited by the peculiar institutional setup and other unique characteristics of Chinese capital market.

Originality/value

This study contributes to literature by providing novel findings on the relationship between information risk and cost of capital in Chinese context and it provides further insight into how and if investors value information risk.

Citation

Safdar, R. and Yan, C. (2016), "Information risk, stock returns, and the cost of capital in China", China Finance Review International, Vol. 6 No. 1, pp. 77-95. https://doi.org/10.1108/CFRI-04-2015-0033