Journal of Economic Behavior Organization Vol. 42 2000 463–482
Comparing alternative explanations for accounting risk-return relations
David L. Deephouse
a,∗
, Robert M. Wiseman
b
a
Department of Management, Louisiana State University, Baton Rouge, LA 70803-6312, USA
b
Department of Management, Michigan State University, East Lansing, MI 48824-1121, USA Received 9 September 1997; received in revised form 9 August 1999; accepted 31 August 1999
Abstract
Research into accounting risk-return relations largely relied on reference-based models of man- agerial choice. This focus ignores other explanations that may contribute to our understanding.
Our study extends prior research by incorporating agency theory and implicit contracts theory into models based on the behavioral theory of the firm. We test our hypotheses in a large sample of
US manufacturing firms in two different economic environments. Our results show some support for each theory, suggesting that multiple frameworks may better explain risk-return relations. Fur-
ther, differences in results between the two economic environments imply that macroeconomic conditions may be important. © 2000 Elsevier Science B.V. All rights reserved.
JEL classification: D81
Keywords: Risk-return; Behavioral theory of the firm; Agency theory; Implicit contracts theory
1. Introduction
Accounting risk-return research has received considerable attention since Bowman 1980 found a negative relationship between accounting risk and return. Most research e.g.,
Fiegenbaum and Thomas, 1988; Bromiley, 1991a; Sinha, 1994 used reference-based mod- els of choice based on the behavioral theory of the firm Cyert and March, 1963 or prospect
theory Kahneman and Tversky, 1979. These models assumed managers decide on their risk preferences after comparing their firm’s performance to certain reference points, such
as industry performance or their firm’s past performance. This focus on reference-based models largely ignored alternate explanations of managerial risk preferences. Therefore,
prior models of risk may be mis-specified and results from prior risk research could be
∗
Corresponding author. 0167-268100 – see front matter © 2000 Elsevier Science B.V. All rights reserved.
PII: S 0 1 6 7 - 2 6 8 1 0 0 0 0 1 0 0 - 1
464 D.L. Deephouse, R.M. Wiseman J. of Economic Behavior Org. 42 2000 463–482
incomplete or erroneous. In particular, few studies of accounting risk-return relations have incorporated agency theory, which is clearly concerned with the risk choices of agents
Coffee, 1988; Barney and Hesterly, 1996; Gomez-Mejia and Wiseman, 1997. A major contribution of this research is that we incorporate agency theory into a model of risk based
on the behavioral theory of the firm. Moreover, we find that the two theories have conflicting predictions on the effect of capital structure on risk.
A second contribution of this study is its examination of a theory-based explanation for how risk reduces return. The arguments linking higher risk to lower return in prior research
have rested on traditional strategic management assumptions that choices of risk must play a significant role in performance. Although intuitively appealing, these arguments
lack a strong theoretical foundation. We apply implicit contracts theory, which suggests that exchange partners accept less favorable contract terms from companies whose income
streams are stable because stability lowers the default risk Shapiro and Titman, 1986; Cornell and Shapiro, 1987.
This study’s third contribution is the examination of accounting risk-return relations in two time periods with distinctly different economic conditions. Fiegenbaum and Thomas
1986 and Wiseman and Catanach 1997 suggested that risk-return relations vary over time and that macroeconomic conditions may account for this variation. We test their spec-
ulation by estimating our model in two adjacent time periods that had dramatically different economic conditions. We develop three hypotheses from theory and also test for an overall
structural change in all the coefficients between the two periods.
This paper is structured as follows. First, we develop hypotheses for risk and then for return. Second, we explain how we tested the hypotheses using a simultaneous equations
model. Third, we present the results of our analysis. Finally, we suggest several ways to advance research on accounting risk-return relations.
2. Model of risk
