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Information Risk and the Cost of Capital
Author(s) -
Eckles David L.,
Halek Martin,
Zhang Rongrong
Publication year - 2014
Publication title -
journal of risk and insurance
Language(s) - English
Resource type - Journals
SCImago Journal Rank - 1.055
H-Index - 63
eISSN - 1539-6975
pISSN - 0022-4367
DOI - 10.1111/j.1539-6975.2013.01526.x
Subject(s) - accrual , cost of capital , equity (law) , business , debt , factor analysis of information risk , liability , actuarial science , economics , finance , microeconomics , incentive , information system , management information systems , electrical engineering , earnings , engineering , political science , law , risk management information systems
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.