Konchitchki, Yaniv and Luo, Yan and Ma, Mary L. Z. and Wu, Feng, Accounting-Based Downside Risk, Cost of Capital, and the Macroeconomy (June 23, 2015). Available for download at SSRN: http://ssrn.com/abstract=2622180

“We develop an earnings downside risk measure that captures the expectation for future downward operating performance. We hypothesize that this measure contains distinct information about firm risk that varies with firms’ cost of capital. Consistent with the validity of our measure, we find that relative to low earnings downside risk firms, high earnings downside risk firms experience more negative operating performance over the subsequent period, are more sensitive to downward macroeconomic states, and are more strongly linked to earnings attributes and other risk-related measures from prior research. In line with our prediction, we also find that earnings downside risk explains variation in firms’ cost of capital, and that this link between earnings downside risk and cost of capital is incremental to several earnings attributes, accounting and risk factor betas, return downside risk, default risk, earnings volatility, and firm fundamentals. Overall, this study contributes to accounting research by identifying a new source of risk derived from financial statements — earnings downside risk — and documenting its incremental ability to explain firms’ cost of capital, also shedding new light on the link between accounting and the macroeconomy.”