Disclosure Quality, Diversification and the Cost of Capital

Posted: 11 Dec 2013

Multiple version iconThere are 2 versions of this paper

Date Written: December 10, 2013

Abstract

Based on a stylized infinite-period and multi-asset model of a securities market, I discuss several aspects of the link between disclosure quality and cost of capital, with a particular focus on how diversification influences this link. I first show that because investors have finite horizons and thus face price risk, disclosure plays a role in determining ex ante cost of capital in such a setting, contrary to the result of Christensen et al. ((2010) Information and the cost of capital: An ex ante perspective. Accounting Review 83: 817–848). With respect to diversification, I highlight the role of three aspects of a ‘large economy’ that influence how disclosure quality affects cost of capital: (1) the number of firms across which risk is distributed; (2) the number of investors among whom this risk is shared; and (3) the number of information signals (disclosures) available to investors from which to extract information. Finally, I extend the model to include the effects of non-rational traders who follow a simple trading heuristic and show that this results in an additional disclosure-contingent factor in equilibrium price that does not diversify away under fairly general conditions.

Keywords: Cost of capital, disclosure quality, diversification

Suggested Citation

Clinch, Greg, Disclosure Quality, Diversification and the Cost of Capital (December 10, 2013). Australian Journal of Management, Vol. 38, No. 3, 2013, Available at SSRN: https://ssrn.com/abstract=2365871

Greg Clinch (Contact Author)

Macquarie Business School ( email )

Eastern Rd.
North Ryde
Sydney, NSW 2109
United States

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