Print
E-MailThis post comes to us from Zhihong Chen, Assistant Professor of Accounting at City University of Hong Kong, Dan Dhaliwal, Professor of Accounting at the University of Arizona, and Hong Xie, Associate Professor of Accounting at the University of Kentucky.
In our paper, Regulation Fair Disclosure and the Cost of Equity Capital, which is forthcoming in the Review of Accounting Studies, we examine the effect of Regulation Fair Disclosure (Reg FD) on the cost of capital using methods recently advanced in the accounting and finance literatures for estimating ex ante or implied cost of equity capital.
Given the critical importance of the cost of capital measures for our study, we use two approaches to estimate the cost of capital. The first approach estimates the cost of capital and long-term growth simultaneously for a portfolio of firms at a particular point in time. The second approach estimates the cost of capital for a firm at a particular point in time using assumed long-term growth and analysts’ earnings forecasts as expected earnings. These two approaches complement each other and thus enhance the reliability of our findings.
In contrast to Duarte et al. (2008) and Gomes et al. (2007), we do not find a significant increase in the cost of capital after Reg FD for U.S. firms. Rather, we find some evidence that (1) the cost of capital decreases significantly for a broad cross-section of U.S. firms in the post-Reg FD period relative to the pre-Reg FD period, and (2) the reduction in the cost of capital post Reg FD is due to medium and large firms but is not significant for small firms. The latter findings contrast with Gomes et al. (2007) who conclude that the cost of capital increases post Reg FD for small and medium firms but remains unchanged for large firms. In addition, we find that the reduction in the cost of capital post Reg FD is generally greater for firms with characteristics indicative of more severe selective disclosure before Reg FD, although results based on one of the portfolio-specific cost of capital estimates do not support such a conclusion. Finally, we find little evidence of a reduction in the cost of capital post Reg FD for ADR firms, which are exempt from Reg FD, whereas we continue to observe some evidence of a reduction in the cost of capital for a sample of U.S. firms matched with ADRs in terms of assets and sales.
Overall, while prior research has suggested that the cost of capital increases after Reg FD, our findings based on the implied cost of capital estimates do not support this conclusion and, if anything, suggest the opposite.
The full paper is available for download here.
