ME  Vol.2 No.4 , September 2011
Accounting Information and Cost of Capital: A Theoretical Approach
ABSTRACT
The primary goal of this study is to provide a theoretical model that shows explicit solutions for equilibrium prices and derives the equilibrium required return for the firm’s stock price. In other words, this theoretical study provides a direct link between accounting information, related to the firm’s reports, and the cost of capital within an equilibrium setting. Accounting information is judged to be of high value because it affects the market’s ability to direct firms’ capital allocation choices. The findings showed that an increase in expected cash flows, coming from improvements in the quality of accounting information, leads to a reduction in the firm’s cost of capital.

Cite this paper
nullN. Apergis, G. Artikis, S. Eleftheriou and J. Sorros, "Accounting Information and Cost of Capital: A Theoretical Approach," Modern Economy, Vol. 2 No. 4, 2011, pp. 589-596. doi: 10.4236/me.2011.24066.
References
[1]   A. Admati and P. Pfleiderer, “Forcing Firms to Talk: Financial Disclosure Regulation and Externalities,” Review of Financial Studies, Vol. 13, No. 3, 2000, pp. 479- 519.

[2]   A. Kyle, “Continuous Auctions and Insider Trade,” Econometrica, Vol. 53, No. 6, 1985, pp. 1315-1355.

[3]   D. W. Diamond and R. Verrecchia, “Disclosure, Liquidity, and the Cost of Capital,” Journal of Finance, Vol. 56, 1991, pp. 1325-1359. doi:10.2307/2328861

[4]   M. Brennan and A. Subramanyam, “Market Microstructure and Asset Pricing: On the Compensation for Illiquidity in Stock Returns,” Journal of Financial Economics, Vol. 34, 1996, pp. 441-464. doi:10.1016/0304-405X(95)00870-K

[5]   E. F. Fama and K. R. French, “Common Risk Factors in the Returns on Stocks and Bonds,” Journal of Financial Economics, Vol. 33, No. 1, 1993, pp. 3-56. doi:10.1016/0304-405X(93)90023-5

[6]   E. Bajo, “The Information Content of Abnormal Trading Volume,” Journal of Business Finance and Accounting, Vol. 37, No. 7-8, 2010, pp. 950-978. doi:10.1111/j.1468-5957.2010.02197.x

[7]   N. Apergis, G. Artikis, S. Eleftheriou and J. Sorros, “Accounting Information and the Cost of Capital: The Effect on Excess Stock Returns-Evidence from Panel Data,” Working Paper No 13-2010, Department of Business Administration, University of Piraeus, 2010a.

[8]   N. Apergis, G. Artikis, S. Eleftheriou and J. Sorros, “Accounting Information, the Cost of Capital and Excess Stock Returns: The Role of Earnings Quality-Evidence from Panel Data,” Working Paper No 17-2010, Department of Business Administration, University of Piraeus, 2010b.

[9]   D. Easley and M. O’Hara, “Information and the Cost of Capital,” Journal of Finance, Vol. 59, No. 4, 2004, pp. 1553-1584. doi:10.1111/j.1540-6261.2004.00672.x

[10]   C. Botosan, “Disclosure Level and the Cost of equity Capital,” The Accounting Review, Vol. 72, No. 3, 1997, pp. 323-349.

[11]   C. Botosan and M. Plumlee, “A Re-examination of Disclosure Level and the Expected Cost of equity Capital,” Journal of Accounting Research, Vol. 40, No. 1, 2002, pp. 21-41. doi:10.1111/1475-679X.00037

[12]   J. Francis, R. LaFond, P. Olsson and K. Schipper, “Costs of Capital and Earnings Attributes,” The Accounting Review, Vol. 79, No. 4, 2004, pp. 967-1010. doi:10.2308/accr.2004.79.4.967

[13]   R. C. Merton, “A Simple Model of Capital Market Equilibrium with Incomplete Information,” Journal of Finance, Vol. 42, No. 3, 1987, pp. 483-510. doi:10.2307/2328367

[14]   C. Barry and S. Brown, “Differential Information and Security Market Equilibrium,” Journal of Financial and Quantitative Analysis, Vol. 20, No. 4, 1985, pp. 407-422. doi:10.2307/2330758

[15]   J. Lewellen and J. Shanken, “Learning, Asset Pricing Tests, and Market Efficiency,” Journal of Finance, Vol. 57, No. 3, 2002, pp. 1113-1145. doi:10.1111/1540-6261.00456

[16]   M. Gietzmann and J. Ireland, “Cost of Capital, Strategic Disclosures and Accounting Choice,” Journal of Business Finance and Accounting, Vol. 32, No. 3-4, 2005, pp. 599-634. doi:10.1111/j.0306-686X.2005.00606.x

[17]   G. Feltham, S. Robb and P. Zhang, “Precision in Accounting Information, Financial Leverage and the Value of Equity,” Journal of Business Finance and Accounting, Vol. 34, No. 7-8, 2007, pp. 1099-1122. doi:10.1111/j.1468-5957.2007.02027.x

[18]   D. W. Diamond, “Optimal Release of Information by Firms,” Journal of Finance, Vol. 40, No. 4, 1985, pp. 1071-1094.

[19]   M. Fishman and K. Haggerty, “The Mandatory Disclosure of Trades and Market Liquidity,” Review of Financial Studies, Vol. 8, 1997, pp. 637-676. doi:10.1093/rfs/8.3.637

[20]   D. Easley, S. Hvidjkaer and M. O’Hara, “Is Information Risk a Determinant of Asset Returns?” Journal of Finance, Vol. 10, 2000, pp. 2185-2221.

[21]   D. Ashton, “Discussion of Cost of Capital, Strategic Disclosures and Accounting Choice,” Journal of Business Finance and Accounting, Vol. 32, No. 3-4, 2005, pp. 635-641. doi:10.1111/j.0306-686X.2005.00607.x

[22]   S. Buchheit and L. M. Parsons, “An Experimental Investigation of Accounting Information’s Influence on the Individual Giving Process,” Journal of Accounting and Public Policy, Vol. 25, 2006, pp. 666-686. doi:10.1016/j.jaccpubpol.2006.09.002

[23]   I. Karamanou and G. P. Nishiotis, “Disclosure and the cost of capital: Evidence from the Market’s Reaction to Firm Voluntary Adoption of IAS,” Journal of Business Finance and Accounting, Vol. 36, No. 7-8, 2009, pp. 793- 821. doi:10.1111/j.1468-5957.2009.02154.x

[24]   Y. Amihud and H. Mendelson, “Asset Pricing and the Bid-Ask Spread,” Journal of Financial Economics, Vol. 17, No. 1, 1986, pp. 223-249. doi:10.1016/0304-405X(86)90065-6

[25]   E. F. Fama, “Foundations of Finance,” New York, Basic Books, 1976.

[26]   R. Masulis, “The Debt/Equity Choice,” Ballinger Publishing Company, Cambridge, Mass, 1988.

[27]   M. Harris and A. Ravin, “The Theory of Capital Structure,” Journal of Finance, Vol. 46, 1991, pp. 297-356. doi:10.2307/2328697

[28]   L. Shyam-Sunder and S. C. Myers, “Testing Static Trade-off against Pecking Order Models of Capital Structure,” Journal of Financial Economics, Vol. 51, No. 3, 1999, pp. 219-244. doi:10.1016/S0304-405X(98)00051-8

[29]   E. F. Fama and K. R. French, “Testing Trade-off and Pecking Order Predictions about Dividends and Debt,” Working Paper, University of Chicago, 2000.

[30]   S. M. Fazzari, R. G. Hubbard and B. C. Petersen, “Investment-Cash Flows Sensitivities are Useful: A Comment on Kaplan and Zingales,” Quarterly Journal of Economics, Vol. 115, No. 2, 2000, 695-705. doi:10.1162/003355300554773

[31]   S. N. Kaplan and L. Zingales, “Investment-Cash Flows Sensitivities are not Valid Measures of Financing Constraints,” Quarterly Journal of Economics, Vol. 115, No. 3, 2000, pp. 707-712. doi:10.1162/003355300554782

[32]   A. Hovakimian and G. Hovakimian, “Cash Flow Sensitivity of Investment”, European Financial Management, Vol. 15, No. 2, 2009, pp. 47-65. doi:10.1111/j.1468-036X.2007.00420.x

[33]   H. Almeida, M. Campello and M. S. Weisbach, “The Cash Flow Sensitivity of Cash,” Journal of Finance, Vol. 59, No. 4, 2004, pp. 1777-1804. doi:10.1111/j.1540-6261.2004.00679.x

[34]   B. D’Espallier and F. Lopez-Iturriaga, “On the Relation between Investment-Cash Flow Sensitivities and Cash- Cash Flow Sensitivities,” Working Paper No. 931, Katholieke Universiteit Leuven, 2008.

[35]   S. H. Penman, “An Evaluation of Accounting Rate of Return,” Journal of Accounting, Auditing, and Finance, Vol. 6, No. 2, 1991, pp. 233-255.

[36]   E. F. Fama and K. R. French, “Size and Book-to-Market Factors in Earnings and Returns,” Journal of Finance, Vol. 50, No. 1, 1995, pp. 131-155. doi:10.2307/2329241

[37]   S. Basu, “Investment Performance of Common Stocks in Relation to their Price-Earnings Ratios: A Test of the Efficient Market Hypothesis,” Journal of Finance, Vol. 32, No. 3, 1977, pp. 663-682. doi:10.2307/2326304

[38]   S. A. Ross, R. W. Westerfield and J. Jaffe, “Corporate Finance,” McGraw-Hill, New York, 2002.

[39]   C. F. Lee, P. Newbold, J. E. Finnerty and C. Chu, “On Accounting-Based, Market-Based, and Composite-Based Beta Predictions: Methods and Implications,” The Financial Review, Vol. 21, No. 1, 1986, pp. 51-68. doi:10.1111/j.1540-6288.1986.tb01106.x

[40]   E. Dyl and R. Hoffmeister, “A Note on Dividend Policy and Beta,” Journal of Business Finance and Accounting, Vol. 13, No. 1, 1986, pp. 107-115. doi:10.1111/j.1468-5957.1986.tb01176.x

[41]   M. Carter and B. H. Shawn-Schmidt, “The Relationship between Dividend Payouts and Systematic Risk: A Mathematical Approach,” Academy of Accounting and Financial Studies Journal, Electronic On-Line Journal, 2008.

[42]   R. Sloan, “Do Stock Prices Reflect Information in Accruals and Cash Flows about Future Earnings,” The Accounting Review, Vol. 71, 1996, pp. 289-306.

[43]   P. Lee, D. Stokes, S. Taylor and T. Walter, “The Association between Audit Quality, Accounting Disclosures and Firm-Specific Risk: Evidence from Initial Public Offerings,” Journal of Accounting and Public Policy, Vol. 22, No. 6, 2003, pp. 377-400. doi:10.1016/j.jaccpubpol.2003.08.003

[44]   M. Drake, J. Myers and L. Myers, “Disclosure Quality and the Mispricing of Accruals and Cash Flow,” SSRN: http://ssrn.com/abstract=985949, 2007.

[45]   A. L. C. Chan, E. Lee and S. Lin, “The Impact of Accounting Information Quality on the Mispricing of Accruals: The Case of FRS3 in the UK,” Journal of Accounting and Public Policy, Vol. 28, No. 3, 2009, pp. 189-206. doi:10.1016/j.jaccpubpol.2009.04.002

[46]   P. Fischer and R. Verrecchia, “Disclosure Bias,” Journal of Accounting and Economics, Vol. 38, 2004, pp. 223-250.

[47]   R. Lambert, “Contracting Theory and Accounting,” Journal of Accounting and Economics, Vol. 32, 2001, pp. 3-8.

 
 
Top