The Endogeneity Bias in the Relation between Cost-of-Debt Capital and Corporate Disclosure Policy
CentER Discussion Paper No. 2005-67
58 Pages Posted: 2 Jun 2005
Date Written: May 2005
The purpose of this paper is twofold. First, we provide a discussion of the problems associated with endogeneity in empirical accounting research. We emphasize problems arising when endogeneity is caused by (1) unobservable firm specific factors and (2) omitted variables and discuss the merits and drawbacks of using panel data techniques to address these causes. Second, we investigate the magnitude of endogeneity bias in Ordinary Least Squares regressions of cost-of-debt capital on firm disclosure policy. We document how including a set of variables which theory suggests to be related with both cost-of-debt capital and disclosure and using fixed effects estimation in a panel dataset reduces the endogeneity bias and produces consistent results. This analysis reveals that the effect of disclosure policy on cost-of-debt capital is 200% higher than what is found in Ordinary Least Squares estimation. Finally, we provide direct evidence that disclosure is impacted by unobservable firm-specific factors that are also correlated with cost-of-capital.
Keywords: Disclosure policy, cost-of-debt capital, endogeneity
JEL Classification: M41, M45, G30, C23
Suggested Citation: Suggested Citation