Accounting Fundamentals and Systematic Risk: Corporate Failure Over the Business Cycle

Accounting Fundamentals and Systematic Risk: Corporate Failure Over the Business Cycle

By
Maria Ogneva, Joseph D. Piotroski, Anastasia A. Zakolyukina
The Accounting Review. September
2020, Vol. 95, Issue 5, Pages 321–350

In this paper, we use accounting fundamentals to measure systematic risk of distress. Our main testable prediction — that this risk increases with the probability of recessionary failure, P(R|F) — is based on a stylized model that guides our empirical analyses. We first apply the lasso method to select accounting fundamentals that can be combined into P(R|F) estimates. We then use the obtained estimates in asset-pricing tests. This approach successfully extracts systematic risk information from accounting data — we document a significant positive premium associated with P(R|F) estimates. The premium covaries with the news about the business cycle and aggregate failure rates. Additional tests underscore the importance of the “structure” imposed through recessionary-failure-probability estimation. The “agnostic” return predictor that relies only on past correlations between the same fundamental variables and returns exhibits markedly different properties.