We thank Stan Baiman, John Cochrane, Gene Fama, Wayne Guay, Raffi Indjejikian, Eugene Kandel, Christian Laux, D. J. Nanda, Haresh Sapra, Cathy Schrand, Phillip Stocken, seminar participants at the Journal of Accounting Research conference, Ohio State University, and the University of Pennsylvania, and an anonymous referee for their helpful comments on this paper and previous drafts of work on this topic.
Accounting Information, Disclosure, and the Cost of Capital
Article first published online: 16 MAR 2007
Journal of Accounting Research
Volume 45, Issue 2, pages 385–420, May 2007
How to Cite
LAMBERT, R., LEUZ, C. and VERRECCHIA, R. E. (2007), Accounting Information, Disclosure, and the Cost of Capital. Journal of Accounting Research, 45: 385–420. doi: 10.1111/j.1475-679X.2007.00238.x
- Issue published online: 16 MAR 2007
- Article first published online: 16 MAR 2007
- Received 7 October 2005; accepted 18 December 2006
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.