A theory of voluntary disclosure and cost of capital

Abstract

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. *

The association between disclosure level and cost of capital in an emerging market: evidence from Egypt

“…Accordingly, increasing disclosure up to the good-practice level has an appreciable effect on the COEC, but the effect of further disclosure beyond this level is marginal (Armitage and Marston, 2008). Similarly, Cheynel (2013) finds that firms making voluntary disclosures have a lower COEC than firms that do not disclose. Yet, if there is more voluntary disclosures among the sample firms (i.e., lower disclosure frictions), it is found that the association between voluntary disclosure and COEC turned to be positive for both disclosing and non-disclosing firms.…”

Disclosure and the Cost of Capital: A Survey of the Theoretical Literature

“…8 Such factor structures are commonly used to clarify in the model the sources of common risks (see, among other examples, Hughes et al, 2007, Caskey et al, 2015, and Cheynel, 2013. As shown by Caskey et al (2015), similar results can also be obtained with a (more general) approach in which the covariance matrix can be written in terms of an 'approximate' factor structure.…”

“…22 We refer to Christensen and Qin (2013) for a formal treatment of disagreement in a dynamic trading model. 23 See Jorgensen and Kirschenheiter (2003), Jorgensen andCheynel (2013). See also Clinch and Verrecchia (2013) for a recent study of this question within a model in which the private information is not fully diversifiable.…”

“…This idea is illustrated in Gao and Liang (2013) which examines the informational connections between price and real decisions, and it is discussed at greater length in the review by Kanodia and Sapra (2016). 34 See Gao (2010), Beyer (2012), Zhang (2013), and Cheynel (2013) for comprehensive treatments of the relationship between the risk premium, welfare, and investment choices.…”

The Forward-Looking Disclosures of Corporate Managers: Theory and Evidence

“…The findings of Easley and O'Hara (2004) suggest that more disclosures by a firm might lower its cost of capital, due to a reduced information risk. Cheynel (2013) employs a model where a firm's disclosures are voluntary, and shows that firms that disclose their information feature lower capital costs than firms that do not disclose.…”