Disclosure and cost of equity capital in emerging markets: The Brazilian case

In this paper, we conjecture that the weak association between disclosure and cost of equity capital found in the literature (Botosan, 1997) can be caused by the high-level corporate disclosure environment found in the United States. We hypothesize that in low-level corporate disclosure environments the variability in disclosure practices across firms will be larger than in the United States, and, consequently, the marginal effect of voluntary disclosure policies will be higher. Using a newly developed Brazilian Corporate Disclosure Index (BCDI), our results confirm this hypothesis. Disclosure is strongly associated with ex ante cost of equity capital for Brazilian firms. The results are more pronounced for firms with less analyst coverage and low ownership concentration, as expected.     

Policy and oversight of corporate political activities and the cost of equity capital

This paper investigates the effect of voluntary adoption and disclosure of policies/oversight of corporate political activities/spending on the cost of equity capital for S&P 500 firms over the period 2015–2018. Using the CPA-Zicklin Index to measure the level of policies, oversight, and disclosure of corporate political activities, we find that firms with a greater level of policies and oversight enjoy a lower cost of equity capital. We also document that a higher index is associated with higher stock liquidity. The negative relation is more pronounced among firms with higher exposure to political risk and firms with higher dependence on government spending. We also find that a firm’s information environment plays an important role in moderating the relation between policies and oversight of corporate political activities and the cost of equity capital. Our findings suggest that voluntary adoption and disclosure of policies and oversight mitigates risks and uncertainties related to firms’ political activities, thereby reducing information asymmetry and the cost of equity capital.     

Transparency,Liquidity, and Valuation: International Evidence on When Transparency Matters Most

We examine the relation between firm‐level transparency, stock market liquidity, and valuation across countries, focusing on whether the relation varies with a firm's characteristics and economic environment. We document lower transaction costs and greater liquidity (as measured by lower bid‐ask spreads and fewer zero‐return days) for firms with greater transparency (as measured by less evidence of earnings management, better accounting standards, higher quality auditors, more analyst following, and more accurate analyst forecasts). The relation between transparency and liquidity is more pronounced in periods of high volatility, when investor protection, disclosure requirements, and media penetration are poor, and when ownership is more concentrated, suggesting that firm‐level transparency matters more when overall investor uncertainty is greater. Increased liquidity is associated with lower implied cost of capital and with higher valuation as measured by Tobin's Q. Finally, a mediation analysis suggests that liquidity is a significant channel through which transparency affects firm valuation and equity cost of capital.     

Annual report readability and the cost of equity capital

Using a large panel of U.S. public firms, we examine the relation between annual report readability and cost of equity capital. We hypothesize that complex textual reporting deters investors' ability to process and interpret annual reports, leading to higher information risk, and thus higher cost of equity financing. Consistent with our prediction, we find that greater textual complexity is associated with higher cost of equity capital. Our results are robust to a battery of sensitivity checks, including use of multiple estimation methods, alternative proxies of annual report readability and cost of equity capital measures, and potential endogeneity concerns. In addition, we hypothesize and test whether the nature of the relation between readability and cost of capital depends on the tone of 10-K filings. Our results show that the effect of annual report complexity on cost of equity is greater when disclosure tone is more negative or more ambiguous. We also find that the effect of annual report readability on cost of equity capital depends on the degree of stock market competition, level of institutional investors' ownership, and analyst coverage.     

Analyst Specialization and Conglomerate Stock Breakups

This paper examines whether firms emerging from conglomerate stock breakups are able to affect the types of financial analysts that cover their firms as well as the quality of information generated about their performance. Our sample comprises 103 focus-increasing spin-offs, equity carve-outs, and targeted stock offerings between 1990 and 1995. We find that, after these transactions, sample firms experience a significant increase in coverage by analysts that specialize in subsidiary firms' industries, and a 30–50% increase in analyst forecast accuracy for parent and subsidiary firms. The improvement in forecast accuracy is partially attributable to expanded disclosure. However, forecast improvements for specialists exceed those for non-specialists, leading us to conclude that corporate focus can facilitate improved capital market intermediation by financial analysts with industry expertise.     

Corporate Governance and Expected Stock Returns: Evidence from Germany

Recent empirical work shows evidence for higher valuation of firms in countries with a better legal environment. We investigate whether differences in the quality of firm‐level corporate governance also help to explain firm performance in a cross‐section of companies within a single jurisdiction. Constructing a broad corporate governance rating (CGR) for German public firms, we document a positive relationship between governance practices and firm valuation. There is also evidence that expected stock returns are negatively correlated with firm‐level corporate governance, if dividend yields are used as proxies for the cost of capital. An investment strategy that bought high‐CGR firms and shorted low‐CGR firms earned abnormal returns of around 12% on an annual basis during the sample period.     

The Real Effects of Financial Shocks: Evidence from Exogenous Changes in Analyst Coverage

We study the causal effects of analyst coverage on corporate investment and financing policies. We hypothesize that a decrease in analyst coverage increases information asymmetry and thus increases the cost of capital; as a result, firms decrease their investment and financing. We use broker closures and broker mergers to identify changes in analyst coverage that are exogenous to corporate policies. Using a difference‐in‐differences approach, we find that firms that lose an analyst decrease their investment and financing by 1.9% and 2.0% of total assets, respectively, compared to similar firms that do not lose an analyst.     

Did Regulation Fair Disclosure,SOX, and Other Analyst Regulations Reduce Security Mispricing?

Between 2000 and 2003 a series of disclosure and analyst regulations curbing abusive financial reporting and analyst behavior were enacted to strengthen the information environment of U.S. capital markets. We investigate whether these regulations reduced security mispricing and increased stock market efficiency. After the regulations, we find a significant reduction in short‐term stock price continuation following analyst forecast revisions and earnings announcements. The effect was more pronounced among higher information uncertainty firms, where we expect security valuation to be most sensitive to regulation. Analyst forecast accuracy also improved in these firms, consistent with reduced mispricing being due to an improved corporate information environment following the regulations. Our findings are robust to controls for time trends, trading activity, the financial crisis, analyst coverage, delistings, and changes in information uncertainty proxies. We find no concurrent effect among European firms and a regression discontinuity design supports our identification of a regulatory effect.     

Compliance with goodwill-related mandatory disclosure requirements and the cost of equity capital

Theory suggests that increased levels of corporate disclosure lead to a decrease in cost of equity via the reduction of estimation risk. We examine compliance levels with International Financial Reporting Standard 3 Business Combinations and International Accounting Standard 36 Impairments of Assets mandated goodwill-related disclosure and their association with firms’ implied cost of equity capital (ICC). Using a sample of European firms for the period 2008–2011, we find a median compliance level of about 83% and significant differences in compliance levels across firms and time. Non-compliance relates mostly to proprietary information and information that reveals managers’ judgement and expectations. Overall, we find a statistically significant negative relationship between the ICC and compliance with mandated goodwill-related disclosure. Further, we split the sample between firms meeting (or not) market expectations about the recognition of a goodwill impairment loss in a given year to study whether variation in compliance levels mainly plays a confirmatory or a mediatory role. We find the latter: higher compliance levels matter only for the sub-sample of firms that do not meet market expectations regarding goodwill impairment. Finally, our results hold only in countries where enforcement is strong.     

Disclosure and the cost of equity in international cross-listing

In this paper, we examine the relationship between disclosure level and the cost of equity capital for a sample of international firms cross-listing on the New York Stock Exchange. Increased disclosure has the potential to reduce information asymmetry, reduce the cost of financing and increase analyst following. Using an international asset pricing model, we find that listing firms experience a decrease in both disclosure risk and systematic risk while matching firms do not. Further, we find that the magnitude of the decrease is related to three types of disclosure: accounting standards; analyst following; and exchange/regulatory investor protection. Our results suggest that increased disclosure through accounting standards is beneficial to investors and that disclosure can be accomplished through information intermediaries, e.g., analyst following. For firms with the lowest levels of disclosure prior to cross-listing, all three types of disclosure appear to be valuable.

Corporate Innovation Strategy,Analyst Forecasting Activities and the Economic Consequences

We examine the impact of corporate innovation strategy on analyst following and forecasting performance, as well as the associated economic consequences. Using a sample of US firms from 1992?2012, we find that firms pursuing an exploration‐oriented innovation strategy (as opposed to an exploitation‐oriented innovation strategy) are associated with lower analyst coverage, higher forecast error and dispersion. The effect is less pronounced for firms with greater disclosure of innovation activities, and for firms followed by analysts with more firm‐specific experience. We also examine how innovation strategy affects the perceived credibility of analyst forecasts and find that investors appear to be less responsive to forecast revisions issued for exploratory firms. Such firms also incur a higher level of cash holdings, greater internal financing, and lower dividend ratio. The findings of this paper advance our understanding of how a public company's choice of innovation strategy affects its performance in the capital markets as well as the associated economic consequences.     

Social disclosure, financial disclosure and the cost of equity capital

We test the relation between financial and social disclosure and the cost of equity capital for a sample of Canadian firms with year-ends in 1990, 1991 and 1992. We find that, consistent with prior research, the quantity and quality of financial disclosure is negatively related to the cost of equity capital for firms with low analyst following. Contrary to expectations, there is a significant positive relation between social disclosures and the cost of equity capital. This positive relationship is mitigated among firms with better financial performance. We consider some biases in social disclosures that may explain this result. We also note that social disclosures may benefit the firm through its effect on organizational stakeholders other than equity investors.     

THE LIQUIDITY ROUTE TO A LOWER COST OF CAPITAL

The managements of many public companies do not pay much attention to the liquidity of their securities. Many if not most CEOs and CFOs feel powerless to affect what goes on in financial markets, and a common attitude among top executives is that maintaining liquidity is the concern of the securities exchanges and the Securities and Exchange Commission. This approach may work for those companies whose stocks are already highly liquid—a group made up mainly of large‐cap companies, as well as a number of smaller high‐flying, high‐tech firms. But, for the vast majority of public companies—especially smaller and mid‐sized firms—this is likely to be the wrong policy. As the authors of this article demonstrated in their pioneering study (published in the Journal of Financial Economics in 1986), liquidity appears to be a major determinant of a company's cost of capital. As their theory suggests and their empirical tests confirmed, the more liquid a company's securities, the lower its cost of capital and the higher its stock price. And, as discussed in this article, academic research since then has produced a large and impressive body of evidence linking greater liquidity to higher stock prices. Although recent technological innovations such as Internet‐based trading have increased liquidity generally, not all companies appear to have benefited equally. The authors offer a number of suggestions for companies intent on increasing the liquidity of their stock. Specifically, they propose that managers do the following: (1) consider measures, such as stock splits, designed to increase their investor base by attracting small investors; (2) seek trading venues for their securities that promise to increase liquidity; and (3) take advantage of the new Internet technology to provide more and better information to investors. Moreover, for smaller companies with little or no analyst coverage, the authors offer the radical suggestion that such companies actually pay analysts to cover their stock, much as companies pay Moody's or Standard & Poors to rate their bonds. This, in the authors' view, would be a more efficient alternative to the current practice of using stock splits to encourage intermediaries to make markets in the firm's shares.     

Quality of Corporate Social Responsibility Disclosure and Cost of Equity Capital: Lessons from China

This article explores the relationship between the quality of corporate social responsibility (CSR) disclosure and the cost of equity capital by analyzing the financial data and CSR reports of A-share listed firms in China from 2008 to 2014. The quality of the CSR disclosure is shown to be negatively related to the cost of equity capital of the listed firms. This negative correlation proves to be more prominent among firms of environmentally sensitive industries. Taking the ownership of the listed firms into consideration, it is further confirmed that the negative relationship between the CSR disclosure and the cost of equity capital is of higher significance for state-owned enterprises. Our findings also empirically demonstrate that the quality of CSR disclosure is more negatively related to the cost of equity capital among the large listed firms than the smaller ones.     

Quality of Corporate Governance and Cost of Equity in Brazil

Common sense suggests that the adoption of better corporate governance practices, which enable greater transparency, more protection against capital expropriation, and greater rights for investors, should have the effect of reducing the risk perceived by shareholders and so lead to lower required returns. This article investigates the existence of an inverse relationship between the quality of corporate governance and the cost of equity capital for Brazilian companies. The authors begin by constructing a broad index of corporate governance quality that combines four key aspects of corporate governance: (1) transparency and disclosure; (2) structure of the board of directors; (3) ownership and control structure; and (4) shareholder rights. To estimate the cost of equity, the CAPM was applied by using ex ante market premiums calculated with a simple discounted‐dividend method. On the basis of a sample of 67 Brazilian companies traded at the São Paulo Stock Exchange (Bovespa) during the period 1998–2008, the study concludes that there is a significant inverse relationship between the cost of equity and a number of proxies for effective governance, particularly those representing transparency and disclosure. Closer inspection of the reductions in cost of capital associated with improvements in the specific governance quality index components suggests that companies would benefit the most from prompt submission of information to regulators and full disclosure of executive pay.     

Corporate Governance,Companies’ Disclosure Practices and Market Transparency: A Cross Country Study

We examine the link between corporate governance, companies’ disclosure practices and their equity market transparency in a study of more than 5,000 listed companies in 23 countries covering the period 1 January 2003 to 31 December 2008. Our results confirm the belief that better‐governed firms make more frequent disclosures to the market. We also find greater disclosure in common law relative to code law countries. However firms with better governance in both code and common law countries make more frequent disclosures. We measure market transparency by the timeliness of prices. In contrast to single country studies, results show, for the 23 countries collectively, better corporate governance is associated with less timely share prices. This would suggest that a firm substitutes better corporate governance for transparency. We are thus led to the conclusion that even if information is disclosed more frequently by better‐governed firms, it does not necessarily follow that information is reflected in share prices on a timelier basis.     

The Wealth Effects of Reducing Private Placement Resale Restrictions

Recently, the US Securities and Exchange Commission reduced resale restrictions on Rule 144 private placements from 12 months to 6 months with the intention of lowering the cost of equity capital for issuing firms. In Canada, similar regulatory changes were adopted several years ago, providing a unique opportunity to test the wealth effects of reducing private placement resale restrictions. We find that shortening resale restrictions reduces the liquidity portion of offer price discounts, and thus lowers the cost of equity capital for issuing firms, but has no significant effect on announcement‐period abnormal returns after controlling for issuer type. However, there is a fundamental shift in the types of firms making private placements of common stock after the legislation‐induced easing of resale restrictions. Specifically, we find that smaller firms and firms with greater information asymmetry are less likely to issue privately placed common stock after the legislative change, suggesting that the easing of resale restrictions reduces the costly signal that helps to overcome the Myers and Majluf (1984) underinvestment problem.     

The influence of ownership structure,analyst following and institutional infrastructure on stock price informativeness: international evidence

Using firms from 20 non‐US countries, we investigate whether and how ownership structure, analyst following and country‐level institutions influence stock price informativeness (SPI). We find that stock price informativeness decreases with control‐ownership wedge (the detachment of voting rights from cash flows rights), and this SPI‐reducing effect of the wedge is attenuated for firms with high analyst following and in countries with strong country‐level institutions. We also find that stock price informativeness decreases with analyst following, but this SPI‐reducing effect of analyst following is attenuated in countries with strong country‐level institutions.     

Does international experience of managers bring financing benefits? Evidence from the cost of equity capital

Using a sample of Chinese firms, this study examines whether and how managers’ overseas experience affects a firm’s cost of equity capital. We document a negative association between managers’ overseas experience and the cost of equity capital. Mechanism analyses indicate that companies with returnee managers have better information quality and lower systematic risk; more institutional investors, media reports, and analysts following; and higher stock liquidity, all of which lead to a lower cost of equity capital. Further analyses show that chief executive officers (CEOs) with foreign experience have a more significant impact on the cost of capital than non-CEO managers with foreign experience and that managers’ overseas work experience has a more significant impact on the cost of capital than their overseas education. We also find that the impact of managers’ overseas experience is more pronounced when that experience is gained in common law countries compared to code law countries but weaker for state-owned enterprises and firms that are cross-listed or have foreign institutional investors. Overall, the results suggest that managers’ knowledge, skills, and ethical values imprinted from overseas experience, plus eyeball effects from media and analyst attention, can reduce the cost of equity capital.     

Are analysts' cash flow forecasts useful?

This study provides evidence that the cost of equity capital decreases with the number of analysts who issue both cash flow and earnings forecasts (cash analysts). The evidence also shows that cash analysts reduce information asymmetry and predict long‐term earnings more accurately than analysts who issue only earnings forecasts. Taken together, these findings suggest that cash analysts provide market participants with high‐quality information and, as a result, firms benefit from cash analyst coverage in the form of a reduced cost of equity capital.