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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

Christian Leuz

University of Chicago - Booth School of Business; National Bureau of Economic Research (NBER); European Corporate Governance Institute (ECGI); Center for Financial Studies (CFS); University of Pennsylvania - Wharton Financial Institutions Center; CESifo Research Network

Catherine M. Schrand

University of Pennsylvania - Accounting Department

Date Written: March 2009

Abstract

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

Leuz, Christian and Schrand, Catherine M., Disclosure and the Cost of Capital: Evidence from Firms' Response to the Enron Shock (March 2009). Chicago Booth School of Business Research Paper No. 08-26. Available at SSRN: https://ssrn.com/abstract=1319646 or http://dx.doi.org/10.2139/ssrn.1319646

Christian Leuz (Contact Author)

University of Chicago - Booth School of Business ( email )

5807 S. Woodlawn Avenue
Chicago, IL 60637
United States
773-834-1996 (Phone)

HOME PAGE: http://faculty.chicagobooth.edu/christian.leuz/

National Bureau of Economic Research (NBER) ( email )

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Cambridge, MA 02138
United States

HOME PAGE: http://www.nber.org

European Corporate Governance Institute (ECGI)

Brussels
Belgium

HOME PAGE: http://www.ecgi.org

Center for Financial Studies (CFS) ( email )

Grüneburgplatz 1
Frankfurt am Main, 60323
Germany

University of Pennsylvania - Wharton Financial Institutions Center

3641 Locust Walk
Philadelphia, PA 19104-6218
United States

CESifo Research Network

Poschinger Str. 5
Munich, DE-81679
Germany

Catherine Schrand

University of Pennsylvania - Accounting Department ( email )

3641 Locust Walk
Philadelphia, PA 19104-6365
United States
215-898-6798 (Phone)
215-573-2054 (Fax)

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