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Abstract:The purpose of this paper is to provide some new evidence on the relationship between disclosure and the cost of equity capital. We propose a new specification for the empirical test based on the idea that in the previous models one crucial variable was missing: accounting policy choice. We test our theoretical hypothesis using a sample of Spanish firms quoted on the Spanish continuous market from 1999 to 2002. We adopt the ex-ante approach to measure the cost of equity capital, taking analysts predictions as a proxy for expected earnings. As an explanatory variable we use an index measuring annual report disclosure quality. This measure of disclosure is combined with a proxy for the accounting policy choice of the firm. We measure firms' conservatism using the modified Jones model of Dechow et al. (1995) to estimate discretionary accruals. Our results confirm that the relationship between disclosure and cost of capital is affected by the choice of accounting policy.

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In this research we consider how disclosure of accounting policy interacts with subsequent choice over voluntary disclosure of a non-financial performance metric. We compare and contrast regimes. In the first, firms are free to choose between a conservative or an aggressive accounting policy before they decide whether to make additional voluntary disclosures. In the other regime, all firms either voluntarily or via mandation use the same accounting policy. We then investigate the cost of raising capital for firms under the two regimes. We show that communication via voluntary disclosure need not be a simple substitute for communication via accounting policy choice.