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Disclosure quality, diversification and the cost of capital

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  • Greg Clinch

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.

Suggested Citation

  • Greg Clinch, 2013. "Disclosure quality, diversification and the cost of capital," Australian Journal of Management, Australian School of Business, vol. 38(3), pages 475-489, December.
    • Handle: RePEc:sae:ausman:v:38:y:2013:i:3:p:475-489
    DOI: 10.1177/0312896213510700
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    References listed on IDEAS

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    Cited by:

    1. Karen Benson & Peter M Clarkson & Tom Smith & Irene Tutticci, 2015. "A review of accounting research in the Asia Pacific region," Australian Journal of Management, Australian School of Business, vol. 40(1), pages 36-88, February.
    2. Taylor, Daniel J. & Verrecchia, Robert E., 2015. "Delegated trade and the pricing of public and private information," Journal of Accounting and Economics, Elsevier, vol. 60(2), pages 8-32.
    3. D.J. Johnstone, 2015. "Information and the Cost of Capital in a Mean-Variance Efficient Market," Journal of Business Finance & Accounting, Wiley Blackwell, vol. 42(1-2), pages 79-100, January.

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    More about this item

    Keywords

    Cost of capital; disclosure quality; diversification;
    All these keywords.

    JEL classification:

    • G10 - Financial Economics - - General Financial Markets - - - General (includes Measurement and Data)
    • G14 - Financial Economics - - General Financial Markets - - - Information and Market Efficiency; Event Studies; Insider Trading

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