Is Information Quality a Priced Risk Factor? : Evidence from the Relation between Accounting Information Quality and Stock Comovement

We find that correlations between returns on stocks are small for firms with poor accounting information quality. Only undiversifiable risk is rewarded with a premium and the undiversifiable risk of a diversified portfolio increases with correlations between returns on its component stocks. Therefore, our finding suggests that accounting information quality is not a priced risk factor. Stocks of firms with poor accounting information quality are prone to large mispricing and, therefore, their stock price movements are idiosyncratic. We show that this high return idiosyncrasy drives the low comovement between their stocks. Consistent with a positive relation between accounting information quality and mispricing, there is an inverted-U relation between accounting information quality and return. Accounting information is the primary source of information to which investors turn for pricing a stock. Therefore, our findings have important implications for the debate over whether information quality is a priced risk factor