Christine A. Botosan

A Re-examination of Disclosure Level and the Expected Cost of Equity Capital

This paper examines the association between the cost of equity capital and levels of annual report and timely disclosure, and investor relations activities. We estimate the cost of equity capital using the classic dividend discount model. We find that the cost of equity capital decreases in the annual report disclosure level but increases in the level of timely disclosures. The latter result is contrary to theory but is consistent with managers’ claims that greater timely disclosures may increase the cost of equity capital, possibly through increased stock price volatility. We find no association between the cost of equity capital and the level of investor relations activities. We conclude that aggregating across different disclosure types results in a loss of information. Failing to include all disclosure types in regression analyses may lead to a correlated omitted variable bias and erroneous conclusions.

Disclosure and the cost of capital: what do we know?

Abstract Whether firms receive cost of capital benefits from greater disclosure is an important and controversial question. This paper reviews the relevant academic research that can provide insights into this question. In conducting this review, my primary objectives are to highlight the implications of existing research for accounting practitioners, standard setters, and academicians, and to address not only the question what do we know, but also the question what do we not know, yet? The overriding conclusion of existing theoretical and empirical research is that greater disclosure reduces cost of capital. Even so, several avenues for future research exist.

Are Information Attributes Priced?: ARE INFORMATION ATTRIBUTES PRICED?

A seminal model in finance links cost of equity capital to information precision, composition and dissemination. Using realized returns to proxy for cost of equity capital and the probability of an informed trade (PIN) to proxy for composition, prior research documents results consistent with the models prediction regarding composition. Nonetheless, prior research that examines the construct validity cautions against the use of future realized returns to proxy for cost of equity capital and recommend r or r instead. The authors speculate but do not demonstrate how the results in existing research might be incorrect due to their use of realized returns. This paper provides such evidence. We find that the authors inference regarding PIN is dependent on their choice of realized returns to proxy for cost of equity capital. We also estimate a more complete specification of the model that includes precision and dissemination, and we decompose PIN into its component parts to isolate that portion of PIN that varies with dissemination. These refinements allow for new insights regarding the veracity of the models predictions. We conclude that cost of equity capital is increasing in composition, and decreasing in dissemination, and find some, albeit not conclusive support, for the prediction that cost of equity capital is decreasing in precision.