AAA Spark Meeting of the Regions

Liquidity Risk, Accounting Quality, and Rewards for Beating Expectations During Periods of High Macroeconomic Uncertainty

• In Event: Impacts of Financial Forecasts

Abstract

This paper examines the effects of liquidity risk and accounting quality on the stock market pricing of beating analyst earnings forecasts during periods of high macroeconomic (macro) uncertainty. We rely on prior theoretical and empirical research suggesting that investors seek portfolio protection during periods of high macro uncertainty by increasing demand for firms with low liquidity risk and high accounting quality. We find that among the group of firms that beat analyst earnings forecasts, firms with lower liquidity risk receive a higher equity market premium, and that this premium increases during high macro uncertainty periods. Results also suggest that investors see through the use of discretionary accruals to beat analyst earnings forecasts and view such beats as being of lower accounting quality, as reflected in a lower premium. We also find that while high accounting quality matters for the pricing of the premium during high macro uncertainty periods, it is limited in its ability to enhance value for firms with high liquidity risk. Results from our study should be useful to analysts, investors, and others interested in understanding factors that influence firm value during high macro uncertainty periods.

Authors

• Bokhyeon Baik, Seoul National University

• Hong Kim Duong, Old Dominion University

• David B. Farber, Indiana University–Purdue University Indianapolis

• Ken W. Shaw, University of Missouri