We appreciate the research assistance of Mingshan Zhang and the helpful comments of an anonymous referee, Abbie Smith (the editor), Maureen McNichols, Robert Bushman, Paul Healy, Jun Pan, Krishna Palepu, Shyam Sunder and workshop participants at the Cheung Kong Graduate School of Business, Harvard Business School, Hong Kong University of Science and Technology, London Business School Stanford Summer Camp, University of Iowa and the 2004 China International Finance Conference.
Earnings Quality, Insider Trading, and Cost of Capital
Article first published online: 13 SEP 2005
Journal of Accounting Research
Volume 43, Issue 5, pages 651–673, December 2005
How to Cite
ABOODY, D., HUGHES, J. and LIU, J. (2005), Earnings Quality, Insider Trading, and Cost of Capital. Journal of Accounting Research, 43: 651–673. doi: 10.1111/j.1475-679X.2005.00185.x
- Issue published online: 13 SEP 2005
- Article first published online: 13 SEP 2005
- Received 21 October 2003; accepted 26 April 2005
Previous research argues that earnings quality, measured as the unsigned abnormal accruals, proxies for information asymmetries that affect cost of capital. We examine this argument directly in two stages. In the first stage, we estimate firms' exposure to an earnings quality factor in the context of a Fama-French three-factor model augmented by the return on a factor-mimicking portfolio that is long in low earnings quality firms and short in high earnings quality firms. In the second stage, we examine whether the earnings quality factor is priced and whether insider trading is more profitable for firms with higher exposure to that factor. Generally speaking, we find evidence consistent with pricing of the earnings quality factor and insiders trading more profitably in firms with higher exposure to that factor.