The Effects of Ownership Structure and Monitoring Mechanisms on Earnings Quality and Cost of Equity

Abstract

This paper examines the relationship between ownership structure (cash flow/voting rights and type of ultimate controlling party), monitoring mechanisms (audit committee and substantial shareholding), various measures of earnings quality and the cost of equity as a form of market assessment of information risk. There is no evidence that ownership structure affects earnings quality and the cost of equity. However, the significant association between substantial shareholding and both earnings quality and cost of equity suggests that substantial shareholding plays a monitoring role. Substantial shareholding has also a role in increasing information flow to the public i.e in reducing information risk and thus is priced by the market. In contrast, the market seems to be indifferent with the rule based mechanism of audit committee. The results suggest that companies just about satisfy the minimum requirement for audit committee whose monitoring role is not evident. This has an important implication on the relative emphasis given by regulators on market and rule based mechanisms.