In this paper we examine whether and how accounting information about a firm manifests in its cost of capital, despite the forces of diversification. We build a model that is consistent with the Capital Asset Pricing Model and explicitly allows for multiple securities whose cash flows are correlated. We demonstrate that the quality of accounting information can influence the cost of capital, both directly and indirectly. The direct effect occurs because higher quality disclosures affect the firm's assessed covariances with other firms' cash flows, which is nondiversifiable. The indirect effect occurs because higher quality disclosures affect a firm's real decisions, which likely changes the firm's ratio of the expected future cash flows to the covariance of these cash flows with the sum of all the cash flows in the market. We show that this effect can go in either direction, but also derive conditions under which an increase in information quality leads to an unambiguous decline in the cost of capital. AbstractIn this paper we examine whether and how accounting information about a firm manifests in its cost of capital, despite the forces of diversification. We build a model that is consistent with the CAPM and explicitly allows for multiple securities whose cash flows are correlated. We demonstrate that the quality of accounting information can influence the cost of capital, both directly and indirectly. The direct effect occurs because higher quality disclosures reduce the firm's assessed covariances with other firms' cash flows, which is non-diversifiable. The indirect effect occurs because higher quality disclosures affect a firm's real decisions, which likely changes the firm's ratio of the expected future cash flows to the covariance of these cash flows with the sum of all the cash flows in the market. We show that this effect can go in either direction, but also derive conditions under which an increase in information quality leads to an unambiguous decline the cost of capital.JEL classification: G12, G14, G31, M41
In this paper we examine whether and how accounting information about a firm manifests in its cost of capital, despite the forces of diversification. We build a model that is consistent with the Capital Asset Pricing Model and explicitly allows for multiple securities whose cash flows are correlated. We demonstrate that the quality of accounting information can influence the cost of capital, both directly and indirectly. The direct effect occurs because higher quality disclosures affect the firm's assessed covariances with other firms' cash flows, which is nondiversifiable. The indirect effect occurs because higher quality disclosures affect a firm's real decisions, which likely changes the firm's ratio of the expected future cash flows to the covariance of these cash flows with the sum of all the cash flows in the market. We show that this effect can go in either direction, but also derive conditions under which an increase in information quality leads to an unambiguous decline in the cost of capital. AbstractIn this paper we examine whether and how accounting information about a firm manifests in its cost of capital, despite the forces of diversification. We build a model that is consistent with the CAPM and explicitly allows for multiple securities whose cash flows are correlated. We demonstrate that the quality of accounting information can influence the cost of capital, both directly and indirectly. The direct effect occurs because higher quality disclosures reduce the firm's assessed covariances with other firms' cash flows, which is non-diversifiable. The indirect effect occurs because higher quality disclosures affect a firm's real decisions, which likely changes the firm's ratio of the expected future cash flows to the covariance of these cash flows with the sum of all the cash flows in the market. We show that this effect can go in either direction, but also derive conditions under which an increase in information quality leads to an unambiguous decline the cost of capital.JEL classification: G12, G14, G31, M41
The paper examines the determinants and performance consequences of equity grants to senior-level executives, lower-level managers, and non-exempt employees of "new economy" firms. We find that the determinants of equity grants are significantly different in new versus old economy firms. We also find that employee retention objectives, which new economy firms rank as the most important goal of their equity grant programs, have a significant impact on new hire grants, but not subsequent grants. Our exploratory performance tests indicate that lower than expected grants and/or existing holdings of options are associated with poorer performance in subsequent years. The Structure and Performance Consequences of Equity Grants To Employees of New Economy Firms AbstractThe paper examines the determinants and performance consequences of equity grants to seniorlev el executives, lower-level managers, and non-exempt employees of"new economy" firms . We find that many of the equity grant determinants and their relative importance vary significantly between new and old economy firms. In addition, we find that employee retention objectiv es, which new economy firms rank as the most important goal of their equity grant programs, have a significant impact on new hire grants, but not on annual, ongoing grants. Our exploratory performance tests indicate that lower than expected option grants and/or ex isting option holdings are associated with lower accounting and stock price performance in subsequent years. However, we find that greater than expected option and equity grants and holdings have little consistent association with future performance.
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