Regulation Fair Disclosure and the Cost of Equity Capital

by R. Christopher Small, for The Harvard Law School Forum at Harvard Law School, March 17, 2010.

In our paper, Regulation Fair Disclosure and the Cost of Equity Capital, which is forthcoming in the Review of Accounting Studies, we examine the effect of Regulation Fair Disclosure (Reg FD) on the cost of capital using methods recently advanced in the accounting and finance literatures for estimating ex ante or implied cost of equity capital.

Given the critical importance of the cost of capital measures for our study, we use two approaches to estimate the cost of capital. The first approach estimates the cost of capital and long-term growth simultaneously for a portfolio of firms at a particular point in time. The second approach estimates the cost of capital for a firm at a particular point in time using assumed long-term growth and analysts’ earnings forecasts as expected earnings. These two approaches complement each other and thus enhance the reliability of our findings.

In contrast to Duarte et al. (2008) and Gomes et al. (2007), we do not find a significant increase in the cost of capital after Reg FD for U.S. firms. Rather, we find some evidence that (1) the cost of capital decreases significantly for a broad cross-section of U.S. firms in the post-Reg FD period relative to the pre-Reg FD period, and (2) the reduction in the cost of capital post Reg FD is due to medium and large firms but is not significant for small firms…(continue reading)

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