The Relationship Between Market And Accounting Determined Risk Measures

College Teaching Methods & Styles Journal – Special Edition 2009

Volume 5, Number 1

The Relationship Between Market
And Accounting Determined Risk
Measures: Reviewing And Updating
The Beaver, Kettler, Scholes (1970) Study
Michael Jarvela, Lakehead University, Canada
James Kozyra, Lakehead University, Canada
Carla Potter, Lakehead University, Canada

ABSTRACT
The association betweenmarket-determined risk measures and accounting-determined risk
measures was originally explored in the 1970s by Beaver, Kettler, and Scholes (BKS). The results
of the BKS (1970) study suggest that accounting information is usefulness in assessing firm
specific risk. Since BKS, there have been few studies conducted to determine if these results still
hold today. This cross-sectional studyre-examines the relationship between market and
accounting-determined risk measures. A total of 222 randomly selected publicly traded companies
were examined to determine if there is a relationship between the accounting risk measures of
dividend payout ratio, leverage, and earnings variability and the market risk measure of beta.
The relationship is further analyzed by classifying the resultsbased on the company’s size (market
capitalization). Our study suggests that the original BKS (1970) results hold true in today’s
market with some exceptions. These findings reiterate the importance of accounting policy choice
and full disclosure in the financial statements, as accounting information proves to be a possible
alternative to market risk information. This demonstrates that fulldisclosure is important to help
capital markets determine a company’s risk profile.
Keywords: Market risk measures; accounting risk measures

1.0

INTRODUCTION

B

eta is one of the most common measure of risk among investors. Beta is a measure of the covariance
of returns for a security compared with t he covariance of returns for the market. Accountants, on the
other hand, have many otherdeterminants of risk including the level of firm leverage, earnings
variability and an inverse relationship to dividend payout. This study examines the relationship between marketdetermined risk measures and accounting-determined risk measures using the methodology set out by Beaver,
Kettler and Scholes (1970) (referred to as BKS (1970) from this point forward). Examining the relationshipbetween market-based and accounting-based risk measures is important for many reasons. Firstly, if both market
and accounting based risk measures are in agreement, investors will be able to rely on accounting determined risk
measures as indicators of company-specific risk in the absence or instability of market risk measures. Secondly,
many investors rely on accounting data as part of theirfundamental analysis when determining risk and reward
expectations. The purpose of this study is to determine if the BKS (1970) results still hold true in the current capital
markets, and to further understand the role of accounting in the capital markets.
To test the relationship, 222 firms were examined. The sample was selected on the basis of market
capitalization, with equal weighting given tofirms with small, medium, and large market capitalization. An OLS
regression estimation was conducted to determine the correlation between the accounting determined risk measures
(earnings variability, dividend payout, and leverage) and the market determined risk measure (beta).
1

College Teaching Methods & Styles Journal – Special Edition 2009

Volume 5, Number 1

The results of theestimation suggest that there is significant relationship between beta and both leverage
and dividend payout; however, we obtained differing results for earnings variability. The discrepancy between our
results for earnings variability and the BKS (1970) findings is particularly surprising because earnings variability
has the highest correlation with beta in the BKS study. Additionally, while the...