Accounting Information, Disclosure, and the Cost of Capital

Abstract

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

Does mandatory IFRS adoption facilitate debt financing?

“…Theory posits that higher quality and more comparable accounting information can reduce information asymmetry and estimation risk (for detailed discussions, see Dye 1990;Verrecchia 2001;Easley and O'Hara 2004;and Lambert et al 2007). Consistent with theory, prior empirical studies have confirmed the role of financial statement information in mitigating agency costs in a debt-financing context.…”

Corporate Governance, Commitment to Business Ethics, and Firm Valuation: Evidence from the Korean Stock Market

“…12 As of December 31, 2008, 763 companies were listed on the Korea Stock Exchange and 1,036 companies were listed on the KOSDAQ. 13 Prior studies speculate that, in general, the companies that are listed in emerging countries have a higher cost of equity capital due to (1) a weaker financial system (Chang, 2005), (2) poor corporate governance (Baek et al, 2004(Baek et al, , 2009Hail and Leuz, 2006), and (3) lack of BE including corporate transparency (Baek et al, 2004;Botosan, 1997;Botosan and Plumlee, 2002;Choi and Jung, 2008;Choi and Nakano, 2008;Dargenidou et al, 2006;Habib, 2006;Lambert et al, 2007;Poshakwale and Courtis, 2005). 14 Pearson and Kendall's s-b correlations were also tested.…”

The voluntary adoption of International Financial Reporting Standards and loan contracting around the world

“…It is thus likely that voluntary IFRS adoption reduces borrowing costs. Lambert et al (2007) provide another reason why high-quality information reduces the cost of external financing. Their analysis indicates that high-quality reports improve coordination between firms and capital suppliers with respect to capital investment decisions, while poor-quality reports lead to misaligned capital investments due to impaired coordination.…”