Cost of Equity Capital, Information Asymmetry, and Segment Disclosure

Abstract

Segment reporting is considered by financial analysts worldwide, to be one of the most important, if not the most important, disclosure in financial reporting. Based on the average of four proxies commonly used to measure the cost of equity capital and a detailed index measuring the level of segment disclosures, this study finds: (1) a significant negative association between the cost of equity capital and the level of segment disclosure, (2) a significant positive association between the cost of equity capital and the probability of information-based trading, and (3) a significant negative association between the cost of equity capital and the interaction term of segment disclosure and the probability of information-based trading. The first two findings provide evidence that the quality of segment disclosure is associated with a lower cost of equity capital and the probability of information based trading (i.e., a measure of information asymmetry among investors) is associated with a higher cost of equity capital. The third finding indicates, when the probability of information based trading is high (higher information asymmetry among investors), the negative association between the cost of equity capital and segment disclosures is stronger.