Information and the Cost of Capital in a Mean‐Variance Efficient Market

Johnstone, David

doi:10.1111/jbfa.12094

Cited by 37 publications

(39 citation statements)

References 49 publications

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“…For example, Johnstone (2014) shows that if information also changes the assessments about the mean of firm value, the cost of capital can increase when information precision increases. As another example, Clinch and Verrecchia (2011) show that the cost of capital can increase if disclosure increases because of a voluntary choice (instead of a commitment to more transparency as shown in Lambert et al, 2007).…”

Section: Effects Of Disclosure Quality and Inside Ownership On The Comentioning

confidence: 99%

Mandatory Disclosure Quality, Inside Ownership, and Cost of Capital

Core¹,

Hail

Verdi³

2014

European Accounting Review

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This paper examines whether and how inside ownership mediates the relation between disclosure quality and the cost of capital. Both ownership and more transparent reporting have the potential to align incentives between managers and investors thereby reducing systematic risk. Employing a large global sample across 35 countries over the 1990 to 2004 period, we show that countrylevel disclosure regulation is negatively related to (i) inside ownership, and (ii) firms' implied cost of capital and realized returns. We then introduce ownership into the cost-of-capital model, and also find a negative relation. These relations extend to the systematic component of the cost of capital, estimated from Fama-French portfolio sorts on ownership and disclosure regulation. Thus, while the direct effect of disclosure on cost of capital is negative, the indirect effect via ownership is positive, consistent with disclosure quality and ownership acting as substitutes. Using path analysis to assess the relative magnitude, our estimates suggest that the direct effect of disclosure quality outweighs the indirect effect by a ratio of about five to one.JEL Classification: G15, G30, G38, K22, M41

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Section: Effects Of Disclosure Quality and Inside Ownership On The Comentioning

confidence: 99%

Mandatory Disclosure Quality, Inside Ownership, and Cost of Capital

Core¹,

Hail

Verdi³

2014

European Accounting Review

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“…Our segment disclosure proxy also controls for the determinants of the difficulty in estimating future earnings. Also, from the findings in Johnstone (2013), one could argue that improved disclosure could lead to higher cost of capital because of the unveiling of certain operational or financial risks. Again, we define our segment disclosure score to control for different types of risk.…”

Section: Introductionmentioning

confidence: 99%

Segment Disclosure and Cost of Capital

Blanco¹,

Lara²,

Tribó

2015

Business Fin & Account

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Abstract:We investigate whether segment disclosure influences cost of capital. Improved segment reporting is expected to decrease cost of capital by reducing estimation risk. However, in a competitive environment segment disclosure may also generate uncertainties about future prospects and lead to a larger cost of capital. Asset-pricing tests confirm that segment disclosure is a priced risk factor. Also, segment disclosure reduces ex-ante estimates of cost of equity capital and other measures connected to risk. These results suggest a negative relation between segment disclosure and cost of capital. Our results also show that competition reduces, but does not eliminate, the previous relationship.

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“…Levitt, 1998;Foster, 2003;Christensen et al, 2010). The correct view, shown by Lambert et al (2007), Gao (2010) and Johnstone (2013Johnstone ( , 2015Johnstone ( , 2016 along effectively identical lines to Fama, is that even if indeed the assessed pay-off covariance does fall on receipt of new information, 9 the rational CAPM cost of capital might still increase as that new information can, if it is unfavourable, bring a sufficient reduction in the perceived mean pay-off. These fundamental pay-off parameters are assessed subjectively based on all existing and new information, including historical data, and can each change in either direction with new information.…”

Section: Information and The Discount Ratementioning

confidence: 91%

When are investment projects in the same risk class?

Johnstone

2015

Accounting & Finance

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If two investments have the same pay-off covariance with the market but one has higher expected pay-off, which asset according to the CAPM has most risk? One answer is that as far as risk goes the two assets are the same, because they have the same covariance with the market. The correct answer, pointed out nearly four decades ago by Eugene Fama, but long overlooked, is that investments have the same risk, the same returns beta and the same CAPM discount rate if and only if they have the same ratio of ex ante pay-off covariance to pay-off mean. This insight clarifies much of the conventional wisdom that surrounds capital budgeting and 'risk-adjusted' discount rates, while also displaying the mechanics by which information arrival affects the CAPM cost of capital.

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Information and the Cost of Capital in a Mean‐Variance Efficient Market

Cited by 37 publications

References 49 publications

Mandatory Disclosure Quality, Inside Ownership, and Cost of Capital

Mandatory Disclosure Quality, Inside Ownership, and Cost of Capital

Segment Disclosure and Cost of Capital

When are investment projects in the same risk class?

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