A theory of voluntary disclosure and cost of capital
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A theory of voluntary disclosure and cost of capital Edwige Cheynel
Received: 11 May 2010 / Accepted: 8 March 2013 Ó Springer Science+Business Media New York 2013
Abstract This paper explores the links between firms’ voluntary disclosures and their cost of capital. Existing studies investigate the relation between mandatory disclosures and cost of capital and find no cross-sectional effect but a negative association in time-series. In this paper, I find that when disclosure is voluntary firms that disclose their information have a lower cost of capital than firms that do not disclose, but the association between voluntary disclosure and cost of capital for disclosing and nondisclosing firms is positive in aggregate. I further examine whether reductions in cost of capital indicate improved risk-sharing or investment efficiency. I also find that high (low) disclosure frictions lead to overinvestment (underinvestment) relative to first-best. As average cost of capital proxies for risksharing but not investment efficiency, the relation between cost of capital and ex ante efficiency may be ambiguous and often irrelevant. Keywords Cost of capital Systematic risk Voluntary disclosure Risk sharing Investment efficiency JEL Classification
D61 G12 G14 M41
1 Introduction I study the association between voluntary disclosure and cost of capital and examine whether cost of capital captures some of the real effects of voluntary disclosure (i.e., investment and risk-sharing efficiency). I address two main questions: first, at the individual firm level, do firms that voluntarily disclose more information experience a lower cost of capital relative to firms that do not disclose? Second, at the E. Cheynel (&) Columbia Business School, Columbia University, 3022 Broadway, New York, NY 10027, USA e-mail: [email protected]
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economy-wide level, do voluntary firm disclosures affect average cost of capital and what are the consequences of such endogenous disclosures on ex ante economic efficiency? Answering the first question allows us to better understand the economic forces underlying firms’ disclosures, their effects on individual firms’ cost of capital, and the cross-sectional differences in costs of capital between disclosing and nondisclosing firms. Providing an answer to the second question can help us tie the average cost of capital with firms’ voluntary disclosures and the level of investment across economies at different stages in their life cycles. Although the evidence is still relatively recent, a number of empirical studies document a negative cross-sectional association between disclosure quality and cost of capital (Botosan 1997; Sengupta 1998; Botosan and Plumlee 2002; Ecker et al. 2006; Francis et al. 2008). In this literature, most of the research uses a cross-sectional research design, comparing differences in cost of capital between firms with different disclosure quality at a given point in time. My first contribution is to demonstrate, within a formal model, that disclosure qualit
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