Banks' voluntary disclosure in the audit committee reports, cost of equity and the mediating role of financial analysts

Abstract

Voluntary disclosure in the audit committee report is expected to provide additional information about the activities undertaken to protect investors. The Securities and Exchange Commission's (SEC) ultimate aim in initially promulgating audit committee disclosure requirements was to reduce firms' cost of equity. However, prior research finds that voluntary disclosure in the audit committee report is akin to impression management. In 2015, the SEC issued a concept release encouraging audit committees to provide additional voluntary disclosures in their reports beyond mandatory requirements. In that context, this paper analyses the effect of the audit committee voluntary disclosure on the cost of equity, with financial analysts playing a mediating role. The sample comprises the top US bank holding companies from 2006 to 2015. We manually code the voluntary disclosure in audit committee reports using a scoring grid. Results show that audit committee voluntary disclosure increases the cost of equity. In addition, the association between voluntary disclosure and the cost of equity is mediated by financial analysts. Hence, we infer that the impression management undertone of voluntary disclosures affects financial analysts' coverage and forecasting properties, which in turn lead to an increase in the cost of equity. The paper's empirical evidence highlights the effects of impression management disclosure by analysing corporate governance voluntary disclosures, cost of equity and financial analysts and brings the issue to the attention of banking regulators, SEC and investors.

“Et tu, Bruté?”: Do audit committees besmirch investors’ desire for increased disclosures?

“…Sahyoun and Magnan (2020) reveal a positive relationship between voluntary disclosure and earnings management, implying that voluntary disclosure is used as a tool for impression management. Moreover, Sahyoun and Magnan (2022) find that audit committee disclosures increase the cost of equity, and this relationship is mediated by financial analysts who perceive these disclosures as impression management. Draeger et al.…”

“…Several prior studies point out that corporate governance research "fails to adequately capture the dynamic, interactive nature of governance" (Brennan & Kirwan, 2015, p. 467). This paper aims to answer the call by Khemakhem et al (2023) and Sahyoun and Magnan (2022) who encourage studies to investigate interactions among governance key players and analyze how interactions affect their behavior. Second, by engaging in a granular analysis of comment letters, this study sheds some light on the nature of interactions between governance parties who are trying to shape the new requirements.…”