Disclosure and the Cost of Capital: Evidence from Firms' Response to the Enron Shock
65 Pages Posted: 23 Dec 2008 Last revised: 25 Nov 2011
Date Written: March 2009
This paper examines the link between disclosure and the cost of capital. We exploit an exogenous cost of capital shock created by the Enron scandal in Fall 2001 and analyze firms' disclosure responses to this shock. These tests are opposite to the typical research design that analyzes cost of capital responses to disclosure changes. In reversing the tests and using an exogenous shock, we mitigate concerns about omitted variables in traditional cross-sectional disclosure studies. We estimate shocks to firms' betas around the Enron events and the ensuing transparency crisis. Our analysis shows that these beta shocks are associated with increased disclosure. Firms expand the number of pages of their annual 10-K filings, notably the sections containing the financial statements and footnotes. The increase in disclosure is particularly pronounced for firms that have positive cost of capital shocks and larger financing needs. We also find that firms respond with additional interim disclosures (e.g., 8-K filings) and that these disclosures are complementary to the 10-K disclosures. Finally, we show that firms' disclosure responses reduce firms' costs of capital and hence the impact of the transparency crisis.
Keywords: Transparency, Disclosure, Cost of capital, Capital-market shocks, Financial crisis, Annual reports, Accounting scandals
JEL Classification: G01, G12, G14, G30, M41, M42
Suggested Citation: Suggested Citation