Cost of Capital and Liquidity of Foreign Private Issuers Exempted from Filing with the SEC: Disclosure Effect or Earnings Quality Effect?

Abstract:     
Prior theoretical research generally predicts a negative association between disclosure quality and cost of capital and a positive association between disclosure quality and liquidity. In this study, we examine the effect on cost of capital and liquidity of a reporting exemption for foreign private issuers (FPI). Specifically, we test for differences in a firm's cost of equity capital, total cost of capital, and liquidity (bid-ask spread) based on exemption status. Our results indicate that, as expected, exempted FPIs, providing less disclosure to the market, exhibit a higher cost of equity capital, higher total cost of capital, and wider bid-ask spread. As a previous study showed that the reporting exemption was associated with lower earnings quality, we further tested our hypotheses conditional on earnings quality. Our results indicate that the primary relations are between earnings quality and cost of capital and disclosure quality and liquidity. These results enhance our knowledge of the characteristics of exempt and reporting FPIs and extend prior empirical evidence on the relations between financial disclosure practices and earnings quality, and cost of capital and firm liquidity.

Keywords: 1934 Exchange Act Rule 12g3-2(b), financial disclosure quality, cost of capital, liquidity, exemption

JEL Classification: M41, M45, M44

working papers series