Idiosyncratic Information, Moral Hazard and Risk Premium∗

While much accounting information is idiosyncratic in nature, economy-wide factors such as accounting standards affect the quality of idiosyncratic accounting information of many firms simultaneously. We study these two features of accounting information by embedding a parsimonious, moral hazard problem into the framework of a multi-firm economy in which project choices are endogenous to accounting information. In our model moral hazard distorts the sharing of idiosyncratic risk but does not affect the sharing of systematic risk. We extend this insight to achieve two results. First, the reduction in the risk premium for idiosyncratic risk is not captured by the risk premium of traded shares. Second, an economy-wide improvement in idiosyncratic information quality reduces the risk premium for idiosyncratic risk but increases the risk premium for systematic risk. Thus, its overall effect on the total risk premium depends on firms’risk profiles. JEL recognition: G12, G14, G31, M41