Mandatory Disclosure Quality, Inside Ownership, and Cost of Capital

Posted: 7 Apr 2015

See all articles by John E. Core

John E. Core

Massachusetts Institute of Technology (MIT) - Sloan School of Management

Luzi Hail

University of Pennsylvania - The Wharton School

Rodrigo S. Verdi

Massachusetts Institute of Technology (MIT)

Multiple version iconThere are 2 versions of this paper

Date Written: April 6, 2015

Abstract

This paper examines whether and how inside ownership mediates the relation between disclosure quality and the cost of capital. Both ownership and more transparent reporting have the potential to align incentives between managers and investors thereby reducing systematic risk. Employing a large global sample across 35 countries over the 1990 to 2004 period, we show that country-level disclosure regulation is negatively related to (i) inside ownership, and (ii) firms’ implied cost of capital and realized returns. We then introduce ownership into the cost-of-capital model, and also find a negative relation. These relations extend to the systematic component of the cost of capital, estimated from Fama-French portfolio sorts on ownership and disclosure regulation. Thus, while the direct effect of disclosure on cost of capital is negative, the indirect effect via ownership is positive, consistent with disclosure quality and ownership acting as substitutes. Using path analysis to assess the relative magnitude, our estimates suggest that the direct effect of disclosure quality outweighs the indirect effect by a ratio of about five to one.

Keywords: Cost of equity, Disclosure regulation, Ownership, Law and finance, International accounting, Legal system

JEL Classification: G15, G30, G38, K22, M41

Suggested Citation

Core, John E. and Hail, Luzi and Verdi, Rodrigo S., Mandatory Disclosure Quality, Inside Ownership, and Cost of Capital (April 6, 2015). European Accounting Review, Vol. 24, No. 1, pp. 1-29, 2015. Available at SSRN: https://ssrn.com/abstract=2590389

John E. Core

Massachusetts Institute of Technology (MIT) - Sloan School of Management ( email )

100 Main Street
E62-416
Cambridge, MA 02138
United States

Luzi Hail (Contact Author)

University of Pennsylvania - The Wharton School ( email )

3641 Locust Walk
Philadelphia, PA 19104-6365
United States
215-898-8205 (Phone)
215-573-2054 (Fax)

Rodrigo S. Verdi

Massachusetts Institute of Technology (MIT) ( email )

Sloan School of Management
100 Main Street E62-666
Cambridge, MA 02142
United States
(617) 253 2956 (Phone)

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