Disagreement and the Cost of Capital

Authors

  • ROBERT BLOOMFIELD,

    1. Johnson School of Management, Cornell University
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  • PAUL E. FISCHER

    1. Smeal College of Business, Penn State University. The authors thank Vic Anand and Sam Bonsall for research assistance, as well as Robert E. Verrecchia, participants at the 2007 Interdisciplinary Accounting Conference in Copenhagen, and workshop participants at Cornell University, University of British Columbia, University of Rochester, University of Pennsylvania, Yale University, and Duke University for their comments.
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ABSTRACT

We assess how forms of disagreement among investors affect a firm's cost of capital. Firms experience a lower cost of capital if investors perceive that other investors are ignoring relevant disclosures (perceived errors of omission), but a higher cost of capital if investors perceive that others are responding to irrelevant disclosures (perceived errors of commission). The impact of these two sources of disagreement on the cost of capital is determined by the distribution of opinion and the nature of disclosure. For example, even though aggregated disclosures reveal less to investors, aggregated disclosures may decrease the cost of capital by eliminating disagreement associated with perceived errors of commission. These and additional results arise because the cost of capital is driven not only by investors’ uncertainty about the firm's future earnings performance, but also by investors’ uncertainty about the evolution of beliefs, which partly determines the path of prices.

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