Costs of Capital and Earnings Attributes

43 Pages Posted: 23 Jun 2003

See all articles by Jennifer Francis

Jennifer Francis

Duke University

Ryan LaFond

Algert Global, LLC

Per Olsson

Duke University

Katherine Schipper

Duke University - Fuqua School of Business

Date Written: May 2003

Abstract

We examine the relation between the cost of equity capital and seven attributes of earnings: quality, persistence, predictability, smoothness, value relevance, timeliness and conservatism. We refer to the first four attributes as accounting-based because measures of these constructs are typically based on accounting information only. We refer to the last three attributes as market-based because proxies for these constructs are typically based on relations between market data and accounting data. Our analysis of the cost of capital effects of these attributes is based on two distinct approaches to measuring the cost of capital: a cross-sectional approach which uses ex ante cost of capital estimates derived from analyst forecast data, and a time-series approach that uses realized returns and asset pricing regressions. Across both sets of tests, we find that firms with the most favorable values of each attribute, viewed individually, enjoy significantly lower costs of capital than firms with the least favorable values. The largest cost of capital effects are found for the accounting-based attributes; within this set, earnings quality has the strongest effects. Among the market-based attributes, value relevance dominates timeliness and conservatism. Considering all attributes together, the results show that investors consistently price earnings quality and earnings persistence, and to a lesser extent, value relevance.

Keywords: cost of capital, earnings quality, persistence, predictability, smoothness, value relevance, timeliness, conservatism

JEL Classification: M41, M44, G12, G29

Suggested Citation

Francis, Jennifer and LaFond, Ryan and Olsson, Per Mikael and Schipper, Katherine, Costs of Capital and Earnings Attributes (May 2003). Available at SSRN: https://ssrn.com/abstract=414125 or http://dx.doi.org/10.2139/ssrn.414125

Jennifer Francis (Contact Author)

Duke University ( email )

Fuqua School of Business
Durham, NC 27708
United States
919-660-7817 (Phone)
919-648-2818 (Fax)

Ryan LaFond

Algert Global, LLC ( email )

One Maritime Plaza
Suite 1525
San Francisco, CA 94111
United States

Per Mikael Olsson

Duke University ( email )

Box 90120
Durham, NC 27708-0120
United States

Katherine Schipper

Duke University - Fuqua School of Business

Box 90120
Durham, NC 27708-0120
United States

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