Disclosure Regulations and the Cost of Capital

Abstract

Due to the growth of publicly held corporations, the quality of corporate financial disclosure has become one of the most important concerns of the accounting profession and the Securities and Exchange Commission (SEC). This concern over the quality of financial disclosure has resulted in various disclosure regulations by the American Institute of Certified Public Accountants (AICPA) and the SEC. For example, effective 31 December 1970, the SEC required multi-product firms to report both the revenue and profit data by line-of-business in their 10-K reports filed with the commission on a periodic basis. In March 1976, the SEC amended regulation S-X via rule 3-17 which requires footnote (or other supplementary) disclosure to conventional historical cost financial statements of certain data restated on a current entry cost basis. The purpose of this paper is to investigate the impact of such disclosure regulations on the cost of capital of the affected firm. Specifically, this paper presents the results of an empirical investigation of the impact of the SEC's requirement to report by line-of-business on the cost of equity capital of the affected firms. The paper is organized as follows. Next section presents a discussion of the likely effects of disclosure regulations on the cost of equity capital and provides motivation for an empirical examination of the question. In order to conduct our empirical investigation, appropriate surrogates for the cost of equity capital are developed in the third section. The fourth section describes the selection of sample firms and the choice of time periods used in this study. Formulation of the test hypothesis, research methodology used and results obtained are discussed next. Last, a brief summary of the study is presented.