Information Risk and the Cost of Capital

Authors

  • David L. Eckles,

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    • David L. Eckles is with the Terry College of Business, University of Georgia. Martin Halek is with the School of Business, University of Wisconsin. Rongrong Zhang is with the College of Business Administration, Georgia Southern University. David Eckles can be reached via e-mail: deckles@uga.edu.
  • Martin Halek,

    Search for more papers by this author
    • David L. Eckles is with the Terry College of Business, University of Georgia. Martin Halek is with the School of Business, University of Wisconsin. Rongrong Zhang is with the College of Business Administration, Georgia Southern University. David Eckles can be reached via e-mail: deckles@uga.edu.
  • Rongrong Zhang

    Search for more papers by this author
    • David L. Eckles is with the Terry College of Business, University of Georgia. Martin Halek is with the School of Business, University of Wisconsin. Rongrong Zhang is with the College of Business Administration, Georgia Southern University. David Eckles can be reached via e-mail: deckles@uga.edu.

Abstract

This article applies a unique accruals measure to empirically test whether accruals quality affects the cost of capital for property–liability insurers. We utilize insurer loss reserve errors to accurately measure the quality of accruals. This measure, as well as conventional accruals measures, is used to investigate the extent to which accruals quality is priced into both debt and equity capital. We find that accruals quality is priced into debt capital; however, we find virtually no evidence that accruals quality is priced into equity capital. Our results should be of particular interest to insurers as it affects pricing ability. Specifically, insurers who provide primary debtholders (i.e., policyholders) less information risk are able to command higher prices. Furthermore, our results suggest that insurance is not a diversifiable asset.

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