Endogeneity and the Dynamics of Voluntary Disclosure Quality: Is There Really an Effect on the Cost of Equity Capital?

Abstract

Research on the effects of voluntary disclosure quality on the cost of equity capital is often plagued by endogeneity concerns. I use a dynamic panel system GMM estimator to minimize these concerns by incorporating the dynamic nature of voluntary disclosure choices. The dynamic panel system GMM approach provides internal instruments from the firm’s history that directly address endogeneity arising from unobserved heterogeneity and simultaneity. By using hand-collected voluntary disclosure scores, I examine the dynamic relation between voluntary disclosure quality and the cost of equity capital in a panel over 10 years. My results suggest that the empirical relation between voluntary disclosure quality and the cost of equity capital becomes insignificant after controlling adequately for potential dynamic endogeneity, simultaneity, and unobserved heterogeneity. This result is robust to an extension to the U.S. market.

Keywords: Voluntary Disclosure Quality, Cost of Equity Capital, Dynamic Panel System GMM Estimation, Dynamic Endogeneity

JEL Classification: C33, C36, G30, M41