Does voluntary disclosure quality pay off? And if so, what are the driving forces behind the relationship of voluntary disclosure quality and the cost of equity capital? This study addresses these and other questions in the context of analyzing the determinants of the cost of equity capital for Swiss firms. The relation between voluntary disclosure quality and cost of equity capital is widely known to be affected by self-selection. Potential endogeneity bias is controlled for by adopting a two-stage least squares approach in a cross-sectional setting. Voluntary disclosure quality is proxied by the annual reports disclosure scores for a well-diversified sample of Swiss firms as developed by the Department of Banking and Finance of the University of Zurich. Further, an ex-ante cost of capital metric derived from the dividend discount model is used in this study. Empirical evidence shows that the association between voluntary disclosure quality and cost of equity differs with a firm's stock listing history. While the relation is predicted to be negative for firms at the IPO stage, it is likely reversed at some point in a firm's stock listing history. These results suggest that analysts' information processing activities negatively moderate the impact of voluntary disclosure quality on firm value. Importantly, the predicted interaction between voluntary disclosure quality and stock listing history remains significant when adjusting for endogeneity.
Table of Contents
1 Introduction
2 Literature Review
2.1 General considerations
2.2 Direct approach
2.2.1 Benchmark analysis (Botosan, 1997)
2.2.2 Financial vs. social disclosure (Richardson & Welker, 2001)
2.2.3 Different disclosure types (Botosan & Plumlée, 2002)
2.2.4 Swiss capital market (Hail, 2002)
2.2.5 Longitudinal analysis (Gietzmann & Ireland, 2005)
2.2.6 Management earnings forecast (Baginski & Rakow, 2008)
2.2.7 Endogeneity bias (Larcker&Rusticus, 2010)
2.3 Indirect approaches
2.3.1 Earnings quality (Francis, Nanda & Olsson, 2008)
2.3.2 Operating cash flow (Cohen, 2008)
2.3.3 Bid-ask spreads (Welker, 1995)
2.3.4 Accounting choice (Leuz & Verrecchia, 2000)
2.3.5 Realized returns (Eugster & Wagner, 2011)
3 Research Design
3.1 Sample selection
3.2 Valuation models
3.2.1 Definitions
3.2.2 The residual income valuation valuation model
3.2.3 The abnormal earnings growth valuation model
3.2.4 Advantages and disadvantages of the models
3.2.5 Cost of equity capital proxy
3.3 Identification strategy
3.3.1 Proxy for disclosure quality
3.3.2 Theoretical foundations and hypothesis development
3.3.2.1 Public and private disclosures and information processing
3.3.2.2 Endogenous disclosure policy
3.3.3 Important firm characteristics
3.3.3.1 Exogenous control variables
3.3.3.2 Instrument candidates
3.3.4 Descriptive statistics
3.3.5 An instrumental variable approach
4 Empirical Results
4.1 Univariate correlations
4.2 Multivariate regression results
4.2.1 Preliminary stage results
4.2.2 2SLS first-stage estimation results
4.2.3 OLS and reduced form estimation results
4.3 Discussion of results
4.3.1 Causality hypothesis
4.3.2 Endogeneity hypotheses
4.3.3 Alternative explanations
4.4 Sensitivity analyses
4.4.1 Market sectors
4.4.2 Analyst following
5 Conclusions
Objectives & Topics
This thesis investigates the causal relationship between voluntary disclosure quality and the cost of equity capital for Swiss firms, specifically accounting for endogeneity bias using a two-stage least squares (2SLS) approach and evaluating the moderating role of a firm's stock listing history.
- Impact of voluntary disclosure quality on the cost of equity capital.
- Methodological challenges of endogeneity and self-selection in corporate disclosure.
- Use of implied cost of equity capital metrics based on accounting-based valuation models.
- Role of analyst information processing and stock listing history as moderators.
- Application of instrumental variable approaches to mitigate endogeneity.
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1 INTRODUCTION
Does voluntary disclosure quality pay off? And if so, what are the driving forces behind the relationship of voluntary disclosure quality and the cost of equity capital? This study addresses these and other questions in the context of analyzing the determinants of the cost of equity capital for Swiss firms.
The cost of capital is a fundamental question for the decision-makers of firms (Easley & O’Hara 2004). When assessing the profitability of investment projects, the firm’s decision is based on the hurdle rate. The capital structure of a firm is directly influenced by the cost of equity capital. Therefore, the performance of a firm’s operations and the profitability of the firm as a whole critically depend on its cost of capital. A firm’s cost of capital primary reflects the market’s perception of the risk associated with investing in a firm’s security, which varies systematically across firms and industries (Gebhardt, Lee, & Swaminathan 2001). Managers can take active measures to mitigate the risk associated with investing in their firm’s stock by providing information to the capital markets. Corporate disclosure is an important source of information, since it helps the capital markets in allocating resources effectively. As Healy & Palepu (2001, p. 406) put it: “Corporate disclosure is critical for the functioning of an efficient capital market”.
Summary of Chapters
1 Introduction: Introduces the research question regarding the impact of voluntary disclosure quality on the cost of equity capital for Swiss firms and outlines the scope of the study.
2 Literature Review: Provides a comprehensive overview of empirical literature on disclosure research, categorized into direct and indirect approaches, and discusses the persistent issue of endogeneity bias.
3 Research Design: Describes the sample selection of 130 Swiss firms, the valuation models utilized for calculating cost of equity capital, and the identification strategy using instrumental variables.
4 Empirical Results: Presents univariate correlations and multivariate regression findings, testing the causality, endogeneity, and sensitivity of the disclosure-cost relationship.
5 Conclusions: Summarizes the study’s findings, notes limitations, and discusses the implications for future research regarding endogeneity in corporate disclosure.
Keywords
Voluntary disclosure quality, Cost of equity capital, Information asymmetry, Endogeneity, Two-stage least squares, Stock listing history, Analyst following, Swiss firms, Corporate reporting, Capital market, Accounting-based valuation, Information risk, Financial analysts, Market liquidity, Disclosure policy.
Frequently Asked Questions
What is the core focus of this research?
This research examines the causal impact of voluntary disclosure quality on the cost of equity capital, focusing specifically on Swiss-listed firms and addressing the challenges posed by endogeneity.
What are the primary themes discussed?
The study centers on the trade-off between the benefits of reduced information asymmetry through disclosure and the associated costs, alongside the impact of firm-specific moderators like stock listing history.
What is the primary goal of the thesis?
The objective is to identify the driving forces behind the variable association of disclosure quality with equity costs while correcting for endogeneity bias using advanced econometric techniques.
Which scientific methodology is employed?
The author adopts a two-stage least squares (2SLS) instrumental variables approach, utilizing a cross-sectional setting to evaluate the causal effects of disclosure choices.
What topics are covered in the main section of the study?
The main sections cover the literature review, the research design involving valuation model definitions and identification strategies, and the comprehensive presentation of empirical regression results.
What characterize the keywords of this work?
The keywords reflect a synthesis of corporate finance and accounting research, including terms like disclosure quality, information asymmetry, equity capital costs, and instrumental variable econometrics.
How does stock listing history moderate disclosure effects?
The study proposes that a longer listing history accumulates public information, which changes how analysts process disclosures, potentially reversing the net effect of voluntary disclosure quality on the cost of equity over a firm's life cycle.
Why are Swiss firms the focus of this analysis?
Swiss firms are chosen because they operate in an environment with significant reporting discretion and low mandatory disclosure levels, providing a unique dataset to observe voluntary disclosure behavior.
What is the author's conclusion regarding 2SLS compared to OLS in this study?
The author finds that while 2SLS is theoretically superior for managing endogeneity, the chosen instruments in the study are potentially weak, leading to the conclusion that standard OLS results remain highly relevant for inference.
- Quote paper
- Dr. Andreas Zweifel (Author), 2012, An Investigation of the Causal Effect of Voluntary Disclosure Quality on Cost of Equity Capital, Munich, GRIN Verlag, https://www.grin.com/document/354793
