CONSIDERABLE EMPIRICAL RESEARCH HAS been directed to the relationship between financial and accounting variables and market based measures of risk.1 The results of this research indicate that some financial (accounting) variables are highly correlated with a market based measure of risk (beta) and are useful in the prediction of future risk. However, there has been relatively little research into the theoretical relationship between financial variables and market determined risk.Hamada [13,14] has researched the relationship between portfolio analysis and corporate finance. More specifically, he has shown that the systematic risk of a firm's common stock should be positively correlated with the firm's leverage. The analytical approach used by Hamada will be discussed more thoroughly below. The approach used in this paper to develop a relationship between systematic risk and leverage draws on the earlier work of Hamada. In the later paper, he adopted a different approach to arrive at a similar conclusion. Lev [19] has shown, using the approach adopted by Hamada [14], that a firm's operating leverage (the ratio of fixed to variable operating costs) is a variable affecting systematic risk.Pettit and Westerfield [30] assumed a discounted cash flow valuation model and separated the individual security return into cash flow and capitalization rate components. They proceeded to analytically develop a two factor model of beta.2 Although the approach which they used is promising, the model which they developed was not readily testable.The purpose of this paper is to provide a theoretical basis for empirical research into the relationship between systematic risk and financial (accounting) variables. Section II develops the assumptions and relationships of the capital asset pricing model. Systematic risk is defined as the /B parameter from this model. In the following sections we will show that, given the assumptions, there is a theoretical relationship between a firm's systematic risk and the firm's leverage and accounting beta. Also, we show that systematic risk is not theoretically related (directly) to the earnings variability, dividends, size or growth of a firm. * Assistant Professor, University of Oregon. The author wishes to acknowledge the helpful comments of William Beaver. 'Beaver, Kettler and Scholes [4], Pettit and Westerfield [30] and Rosenberg and McKibben [31] conducted tests involving many financial and accounting variables. Ball and Brown [2], Gonedes [11, 12] and Beaver and Manegold [5] were primarily concerned with the relationship between systematic risk and "accodnting beta." 2 See Sharpe [33] for a general theoretical model for this approach. 617 618 The Journal of Finance

An important methodological approach to market based empirical research in finance and accounting is the event study. Also known by other names such as residual analysis and abnormal performance index tests, these studies involve the analysis of security price behavior around the time of an information announcement or event. The approach has been used to study a variety of events such as the announcements of annual accounting earnings, accounting principle changes, large block trades and corporate mergers.A very broad interpretation should be placed on what constitutes an event.Research to date has primarily been in the context of an announcement as the event and usually an announcement emanating from a fm. However, announcements from outside of fm (e.g., from an accounting standard setting body) or more general "happenings" (e.g., an oil embargo) are includable as events.The broad class of research which can be labelled event studies can have numerous objectives and methodological adaptations. The diversity of the event study literature, both in terms of the range of topics covered and specific technique choices available, can be overwhelming. Yet, the structure of event studies is rather straightforward. The purpose of this paper is to provide a structure for the design of event studies, to differentiate them by type and to discuss some issues which are crucial to their understanding. What have come to be known as event studies have their modem roots in studies by Elall and Brown (1968) and Fama, Fisher, Jensen and Roll (1969).' Ball and Brown investigated the security price reaction to the unanticipated component of annual accounting earnings. They found that 85 to 90 percent of the information contained in the annual earnings report had been reflected in security prices before the announcement date. At the time this result was first published, many people, particularly in accounting, found it disconcerting, if not threatening. However, upon reflection, the result should not have been a surprise. The result implies an eminently reasonable information milieu where various sources, including interim earnings reports, are utilized in forming expectations of the annual earnings. The announcement of the annual accounting earnings report, after year end, then serves to revise the previous estimates. *The author is Associate Rofessor 01 Accounting at the University of Oregon. Earlier versions of this paper were presented at workshops at Momsh University and the University of Queenskmd. The author acknowledges the he@jid cornments of the workshop participants, particularly Bob Ofker. In addition, the comments of L. Dann, G. Foster, R. King, T. O'KeefeandB. Spicer helped to shmpen the exposition and organization of the paper. (

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