Disclosure Level and Expected Cost of Equity Capital: An Examination of Analysts' Rankings of Corporate Disclosure
44 Pages Posted: 15 Feb 2000
Date Written: January 2000
This paper examines the association between expected cost of equity capital and three types of disclosure (annual report, quarterly and other published reports, and investor relations). Our sample consists of 3,620 firm-year observations with Value Line data, which are also included in the AIMR's Annual Reviews of Corporate Reporting Practices dated from 1985/1986 through 1995/1996. The disclosure rankings produced by the AIMR are employed to proxy for disclosure level. Four alternative estimates of expected cost of equity capital estimates are examined. However, we conclude that two of these approaches, that employed in Botosan (1997) and an approach based on a finite horizon specification of the Gordon growth model, dominate the other two.
As expected, we find that cost of equity capital is decreasing in annual report disclosure level. The magnitude of the difference in cost of equity capital between the most and least forthcoming firms is approximately one-half to one percentage point, after controlling for market beta and firm size. Contrary to our expectations, we find a positive association between cost of equity capital and the level of more timely disclosures, such as the quarterly report. The magnitude of the difference in cost of equity capital between the most and least forthcoming firms is approximately one to two percentage points, after controlling for market beta and firm size. This result, while contrary to that predicted by theory, is consistent with managers' claims that greater timely disclosures increase cost of equity capital, possibly through increased stock price volatility. Finally, we find no association between cost of equity capital and the level of investor relations activities.
These results confirm and extend the results of Botosan (1997) to include larger, more heavily followed firms, across a diverse group of industries, over a number of years. In addition, they suggest that aggregating across different types of disclosure results in a loss of information and potentially erroneous conclusions.
JEL Classification: G12, M41, M45
Suggested Citation: Suggested Citation