This paper explores the links between firms' voluntary disclosures and their cost of capital. I relate the differences in costs of capital between disclosing and nondisclosing firms to disclosure frictions and equity risk premia. Specifically, I show that firms that voluntary disclose their information have a lower cost of capital than firms that do not disclose. I also examine the extent to which reductions in cost of capital map into improved risk-sharing and/or greater productive efficiency. I prove that high (low) disclosure frictions lead to overinvestment (underinvestment) relative to first-best. Economic efficiency decreases as the disclosure friction increases because of inefficient production in an underinvestment equilibrium. As the disclosure friction continues to increase, the equilibrium switches to overinvestment and further increases in the disclosure friction improve risk-sharing. Importantly the relation between average cost of capital and economic efficiency is ambiguous. A decrease in average cost of capital in the economy only implies an increase in economic efficiency if there is overinvestment. *
How should a firm measure a productive asset used as collateral? To answer this question, we develop a model in which firms borrow funds subject to collateral constraints. We characterize the qualities of optimal asset measurements and analyze their interactions with financing needs, collateral constraints, and interest rates. Because of real effects, complete transparency would reduce contracting efficiency and, hence, the measurement must be suitably adapted to credit conditions. The optimal measurement is asymmetric and reports precise information about high collateral values if credit frictions are low, but the reverse if credit frictions are high. Tighter credit market conditions may lead to more opaque measurements and increased investment, in the form of inefficient continuations.
Although researchers often view earnings management as being widespread, measuring the cost and level of earnings management is a nontrivial task. We derive a measure of earnings management cost and the associated equilibrium level of earnings management from the cross-sectional properties of earnings and prices. This approach enables us to separate economic shocks from reporting discretion by modeling the economic tradeoff faced by management. The tradeoff can be easily estimated from a closed-form likelihood function. Consistent with prior studies, the measure suggests more earnings management during seasoned equity offerings, for smaller and growing firms, as well as in industries with more irregularities. This paper was accepted by Suraj Srinivasan, accounting.
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