Disclosure Incentives and Effects on Cost of Capital around the World

Abstract

Prior research predicts that firms reliant on external financing are more likely to undertake a higher level of disclosure, and a higher disclosure level should, in turn, lead to a lower cost of external financing. This paper tests these predictions outside the United States where alternative legal and financial systems could mitigate the effectiveness of such disclosures and, comprehensively, examines both disclosure incentives and disclosure consequences on cost of capital for a common set of firms. Using a sample from 34 countries, we find that firms in industries with greater external financing needs have higher voluntary disclosure levels, and that an expanded disclosure policy for these firms leads to a lower cost of both debt and equity capital. Crosscountry differences in legal and financial systems affect observed disclosure levels in predicted ways. However, a surprising result in the study is that voluntary disclosure incentives appear to operate independently of country-level factors, which suggests the effectiveness of voluntary disclosure in gaining access to lower cost external financing around the world.

Individual investors and financial disclosure

“…Consistent with this objective, there is extensive research examining how the market as a whole, institutional investors, and analysts respond to more useful and understandable financial disclosures. Specifically, several studies document that higher quality financial disclosures are positively associated with general market liquidity (e.g., Diamond and Verrecchia 1991;Welker 1995;Healy et al 1999), institutional ownership (e.g., Healy et al 1999;Bushee and Noe 2000), analyst forecast accuracy and analyst following (e.g., Barron, Kim, Lim, and Stevens 1998;Lang and Lundholm 1996;Hope 2003), and are negatively associated with the ex ante cost of equity capital (e.g., Leuz and Verrecchia 2000;Easley and O'Hara 2004;Francis, Khurana, and Pereira 2005) and agency costs (e.g., Berger and Hann 2007;Hope and Thomas 2008). SFAC No.…”

The Relationship Between the Intellectual Capital Disclosure and Cost of Debt Capital – A Case of Slovenian Private Audited Organisations

“…Considering that lenders are the main source of external financing for private organisations (Koren et al, 2014), they can be labelled as the most important or powerful stakeholder(s) for those. Further, (voluntary) disclosure levels are positively associated with leverage (Hossain et al, 1995;Ahmed & Courtis, 1999) or with the organisation's need for external financing (Francis et al, 2005). Additionally, in accordance with signalling theory, it is expected that organisations with low(er) leverage ratio and a great need for external (debt) financing are more motivated to send signals to the (financial) market about their financial structure and they will consequently disclose more information voluntarily (Khlifi & Bouri, 2010).…”

“…However, Francis et al (2005Francis et al ( , p. 1128 note that "there are equity markets in countries with more bank-oriented systems, and, therefore, voluntary public disclosure could still be important as means of accessing equity financing as well as creating greater transparency for private debt financing." Hussainey and Aal-Eisa (2009) have shown that the disclosure of forward-looking information in narratives of the annual reports is an important mechanism for signalling future earnings to professional users such as financial analysts.…”

“…Nevertheless, organisations with higher need for external financing (e.g. private organisations) will voluntarily disclose more information (Francis et al, 2005), and because lenders of private organisations will likely make use of all publicly available information (e.g. annual reports) (Peek et al, 2010) 8 , annual reporting for larger private organisations with (mandatory and voluntary) audited annual reports may still be regarded as an important communication channel with external stakeholders.…”

“…Based on the fact (1) that the association between intellectual capital disclosures and the cost of debt capital has been proven for listed organisations (Orens et al, 2009;Hsuehchang, 2013), (2) that larger private organisations may also face agency issues between management/owners and lenders (Kosi & Valentincic, 2013), that (3) organisations that depend on external financing are likely to undertake an expended disclosure policy (Francis et al, 2005), and that "creditors of private firms will likely make use of all publicly available information" (Peek et al, 2010, p. 54), so private organisations may use annual reports as an important communication channel for additional/intellectual capital information, and given that (4) the information about intellectual capital of private organisations is publicly available in their audited annual reports, and considering (5) the importance of debt/loans financing in bank-based economies (as is Slovenian economy 3 ), and taking into account (6) the credit crunch 4 economic situation in the years 2013 and 2014 in Slovenia, a research question whether intellectual capital disclosures of private audited organisations are associated with the cost of debt capital, i.e. whether they are associated with the bank's decisions when granting loans, arises.…”