The Risk-Relevance of Accounting Data: Evidence from the Spanish Stock Market Begon ˜a Giner University of Valencia, Spain Carmelo Reverte Technical University of Cartagena, Spain Abstract This paper analyses the relevance of accounting fundamentals to inform about equity risk as measured by the cost of equity capital. Assuming the latter is a summary measure of how investors make decisions regarding the allocation of resources, the strength of the association between the cost of capital and the accounting-based measures of risk indicates how important these measures are for market participants when making economic decisions. To infer the cost of equity capital, we use the O’Hanlon and Steele’s method, which is based on the residual income valuation model. Moreover, we use the insights from this model to provide a theoretical underpinning for the choice of the accounting variables related to risk. The sample refers to the non-financial firms listed in the Madrid Stock Exchange along the period 1987–2002. Our results support our initial expectations regarding the association between the cost of equity capital and the accounting-based risk variables, thereby supporting the usefulness of fundamental analysis to determine the risk inherent in share’s future payoffs. In particular, we highlight the role of investing risk, which has been ignored in previous research. Our results are also robust to measures of risk other than the cost of capital such as the variability in total returns and the firm’s systematic risk (b). 1. Introduction The objective of this paper is to analyse the relevance of several accounting fundamentals to capture the firm underlying economics that determine its level of business risk. While fundamental valuation of shares requires the estimation of expected future payoffs and the risk inherent in them, as Baginski and Wahlen (2003, p. 328) state, ‘‘existing research on the usefulness of accounting earnings numbers has devoted far more attention to their role as payoff-relevant information than to We are grateful to the participants in the 26 th Annual Congress of the European Accounting Association (Seville, 2003), the Workshop on Capital Market Research in Accounting (Frankfurt, 2003) and the Workshop on Empirical Research in Financial Accounting (Alicante, 2003) for their useful comments on an earlier version of this paper. We also thank Stephen Penman for his unvaluable comments. This work is part of the research project SEJ 2005-08644-C02-01 funded by the Spanish Ministry of Education and Science and ERDF. Journal of International Financial Management and Accounting 17:3 2006 r Blackwell Publishing Ltd. 2006, 9600 Garsington Road, Oxford OX4 2DQ, UK and 350 Main Street, Malden, MA 02148, USA.