Accounting Papers

Document Type

Journal Article

Date of this Version

5-2007

Publication Source

Journal of Accounting Research

Volume

45

Issue

2

Start Page

385

Last Page

420

DOI

10.1111/j.1475-679X.2007.00238.x

Abstract

In this paper we examine whether and how accounting information about a firm manifests in its cost of capital, despite the forces of diversification. We build a model that is consistent with the Capital Asset Pricing Model and explicitly allows for multiple securities whose cash flows are correlated. We demonstrate that the quality of accounting information can influence the cost of capital, both directly and indirectly. The direct effect occurs because higher quality disclosures affect the firm's assessed covariances with other firms' cash flows, which is nondiversifiable. The indirect effect occurs because higher quality disclosures affect a firm's real decisions, which likely changes the firm's ratio of the expected future cash flows to the covariance of these cash flows with the sum of all the cash flows in the market. We show that this effect can go in either direction, but also derive conditions under which an increase in information quality leads to an unambiguous decline in the cost of capital.

Copyright/Permission Statement

This is the peer reviewed version of the following article: LAMBERT, R., LEUZ, C. and VERRECCHIA, R. E. (2007), Accounting Information, Disclosure, and the Cost of Capital. Journal of Accounting Research, 45: 385–420., which has been published in final form at doi: 10.1111/j.1475-679X.2007.00238.x. This article may be used for non-commercial purposes in accordance with Wiley Terms and Conditions for Self-Archiving http://olabout.wiley.com/WileyCDA/Section/id-820227.html#terms.

Keywords

cost of capital, disclosure, information risk, asset pricing

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Date Posted: 27 November 2017

This document has been peer reviewed.