Earnings Quality and the Coinsurance Effect

Julia Nasev and Dominik von der Emde

Chapter 26 in Handbook of Investment Analysis, Portfolio Management, and Financial Derivatives:In 4 Volumes, 2024, pp 861-891 from World Scientific Publishing Co. Pte. Ltd.

Abstract: We argue that coinsurance among a firm’s business units changes the properties of reported earnings through less volatile operations (financial synergies) and fewer estimation errors in the accrual process (accounting synergies). Consistent with a coinsurance effect, we find that diversified firms have on average higher earnings quality compared to industry-matched portfolios of focused firms. Specifically, diversification leads to more predictable earnings, superior mapping of accruals to cash flows, and lower absolute abnormal accruals. In addition, we find higher earnings quality for diversified firms with less correlated segment earnings and that the coinsurance effect is stronger for firms that operate in more volatile and uncertain environments. We contribute by identifying the coinsurance effect of diversification as a new determinant of earnings quality. Our findings complement prior literature on agency-related disadvantages of diversification for earnings quality by highlighting coinsurance related benefits of diversification for earnings quality.

Keywords: Financial Accounting; Financial Auditing; Mutual Funds; Hedge Funds; Asset Pricing; Options; Portfolio Analysis; Risk Management; Investment Analysis; Momentum Analysis; Behavior Analysis; Futures; Index Futures; CDCs; Financial Econometrics; Statistics; Financial Derivatives; Financial Accounting (search for similar items in EconPapers)
JEL-codes: G1 G11 G12 G3 M41 M42 (search for similar items in EconPapers)
Date: 2024
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