Dimensions of disclosure and the cost of equity capital
Rakow, Kenneth Carl
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Prior research provides mixed evidence on disclosure’s effect on cost of equity capital. I investigate these mixed results by delineating disclosure into four separate dimensions - type, quantity, precommitment, and quality – and measure how quantity, precommitment, and quality affect cost of equity capital, holding type constant. Recognizing the endogeneity associated with these dimensions and using a sample of management earnings forecasts from 2001 and 2002, I find evidence that precommitment, quantity, and quality, individually, have a negative association with cost of equity capital as predicted by theoretical research. When all dimensions are considered jointly, disclosure precommitment is negatively related to cost of equity capital and the remaining dimensions are unrelated or weakly related to cost of equity capital. I also document that cost of equity capital increases around the act of disclosure. Management forecasts with lower expected bias, issued over longer horizons, and which lead to lower levels of uncertainty about future earnings attenuate the increases in cost of equity capital surrounding the act of disclosure. My results suggest that a firm’s maintained commitment of issuing forecasts in periods of high information asymmetry (precommitment) is more effective in lowering cost of equity capital than issuing higher quality forecasts (quality) or issuing a forecast at regular intervals (quantity), given that quantity and quality are generally insignificant after controlling for precommitment.
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