What Affects Factor Loading Uncertainty and Expected Returns? The Role of Accounting Quality

Abstract

Despite considerable research on the association between accounting quality and expected returns, much is yet to be learnt about specific underlying mechanisms. Motivated by recent advancements in theoretical work, this study empirically examines how firm-specific information quality affects expected returns through its impact on the uncertainty of estimating factor loadings in asset pricing models. We document that the quality of accounting information is negatively associated with factor loading uncertainty. This result is robust to alternative measures of accounting quality and various model specifications. In addition, we document that factor loading uncertainty is negatively associated with expected returns. Together, our analyses present a coherent set of findings suggesting that factor loading uncertainty serves as an important underlying channel through which accounting quality is related to the cross-section of stock returns, thus providing new insight into the mixed findings reported in prior studies on the relation between accounting quality and expected returns.