Disclosure and cost of equity capital in emerging markets: the brazilian case

AutorAlexsandro Broedel Lopes - Roberta Carvalho de Alencar
Páginas70-92

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1. Introduction

There is an important strand of the financial accounting literature that investi-gates the relation between disclosure and cost of equity capital (Botosan, 1997; Bo-tosan & Plumlee, 2002; Hail, 2002; Fran-cis, Khurana, & Pereira, 2005; Chen, Chen, & Wei, 2003). The basic idea is that higher levels of disclosure contribute to a reduc-tion in information asymmetry between managers and investors and, consequently, cause a reduction in the idiosyncratic com-ponent of cost of equity capital (Verrechia, 2001; Diamond & Verrechia, 1991). How-ever, results of these investigations have notbeenconclusive (Botosan, 1997). Some authors (e.g., Hail, 2002) argue that the ab-sence of statistical and economically signi-ficant associations between disclosure and cost of capital canbe the result of measure-ment problems because both variables are not directly observed and proxies need to be used. In this paper, we investigate ano-ther possibility. We conjecture that the weak relation between firm-level disclosure measures and cost of equity capital is not significant inthe United States because the overall disclosure level is already high and firm-level actions do not have a significant marginal impact. Consequently, the weak association between disclosure and cost of capital observed in the United States may result from low variation in disclosure levels because the mandatory disclosure threshold is already high. We be-lieve that firms' actual disclosure policies depend on their incentives. However, incentives only play an important role if the firm's chosen level of disclosure is superior to the minimum level required by the market regulator. If the firm's policy put its disclosure level below the minimum required level, then it has to be increased by force of regulation. Thus, if the minimum disclosure level is already high, many firms will not adopt their optimal policies and instead will adopt the minimum level. Consequently, the disclosure variation will be reduced in the whole sample of firms. Conversely, in environments where the re-

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quired minimum disclosure level is not so high, it is more likely that firms will pre-sent a higher cross-sectional variation in actual (adopted) disclosure policies. Based on prior research (Lopes & Walker, 2008), this high variation in disclosure levels is what we expect to see in Brazil.

One could argue about the relevance of a single-country analysis. Recent cross-sectional studies (Francis et al., 2005) in-vestigated the relation between disclosure indexes and cost of equity capital for a sample of firms extracted from 34 coun-tries. We believe that more detailed wi-thin-country studies can complement the results of cross-country investigations. We believe there is considerable sample selec-tion bias in the databases used in recent work. In Francis et al. (2005), for exam-ple, only 10 Brazilian firms are covered and there is no discussion about sample selection procedures and representative-ness. Other studies that investigate corporate governance arrangements across a lar-ge number of firms have the same pro-blem. Doidge et al. (2007) consider only 28 Brazilian firms of which 14 are cross-listed. Lang, Raedy, & Wilson (2006) only consider 1 Brazilian firm. We believe the-se small and biased samples can compro-mise the results.

To investigate our hypothesis, we built a detailed disclosure index and appli-ed it to a more representative sample of fir-ms listed in Brazil. To proxy for disclosure, we built the Brazilian Disclosure Index (BCDI), which measures disclosure across 6 components and 47 specific attri-butes. The index is applied to the 50 most liquid shares traded onthe São Paulo Stock Exchange (Bovespa) for the years 1998, 2000,2002,2004, and 2005. Our sample is very close to the Bovespa Index, which is composed of the most liquid shares. The index is based on a set of questions used in previous research (Botosan, 1997; Francis et al., 2005) and adaptations to reflect Brazilian regulations and accounting standar-ds. Table 1 features the questionnaire and the percentage of positive answers. Our questionnaire was not sent to the firms or to analysts; rather, it is based on objective answers obtained from public sources of information — annual reports, websites, Bovespa filings, and the files obtained from the Brazilian Securities and Exchange Commission (CVM). Answers are bina-ry, with 1 indicating a positive answer and 0 indicating a negative answer. We believe that the BCDI provides a comprehensive picture of corporate disclosure policies in Brazil. We are not aware of a detailed in-vestigation of disclosure policies done out-side the United States. To measure cost of equity capital, we used the model proposed by Ohlson & Juetnner-Nauroth (2005), which has been used in previous papers (e.g., Francis et al., 2005).

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The results confirm our hypothesis. Initially we observe a lower mean and great-er variation in disclosure scores in Brazil than previously reported in the United States (Botosan, 1997), Swiss (Hail, 2002) and for a sample of developed countries (Francis et al., 2005) corroborating the idea that in low-level disclosure environ-ments there will be more cross-sectional variations in disclosure policies. It is very hard to perform international comparisons between our index (BCDI) and the indexes used in previous studies because they use different methodologies and consequently arrive at different results. However, we be-lieve our findings are robust because this phenomenon (huge variation in disclosure policies) has already been reported in the literature, which our evidence corrobora-tes. Francis et al. (2005), see Table 2) re-ports the disclosure levels in 34 countries according to the Center for International Financial Analysis Research (CIFAR) index. Brazil presents the higher standard deviation of the 34 countries investigated. Standard deviation for the subsample of Brazilian firms is 17.11, while the mean deviation number for all countries is 7.09. For the United States, the standard deviation of the CIFAR metric is 4.42. Thus, we believe there is compelling evidence (ba-sed on our study as well as others) that the variation of disclosure levels in Brazil is far superior to the levels in other develo-ped countries and especially to the levels in America.

Our main analysis reveals that disclosure levels measured by the BCDI are ne-gatively associated with cost of equity capital for our sample of Brazilian firms using a panel data specification and seve-ral control variables as suggested by Lar-cker & Rusticus (2005) and Nikolaev & van Lent (2005). This result shows a more significant association between voluntary disclosure actions and cost of capital for firms immersed in the low-disclosure Brazilian regime than previously found in the United States. Additionally, we investigate the relation between the six BCDI compo-nents and cost of capital. Interestingly, results show that the relation between disclo-sures of non-financial information is posi-tively correlated with cost of capital. One possible explanation for this result is that firms can reveal valuable proprietary information about their business activities through voluntary disclosure of non-financial information (Verrechia, 2001). One al-ternative explanation for this result is that non-financial information is disclosed more frequently and, consequently, is more used by speculators which induce volatili-ty in stock returns thus increasing cost of capital. Unfortunately, we do not have evidence to prove which of the following ex-planations is better suited for our sample.

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This table presents descriptive statistics for a sample selected of the 50most liquid shares (trading volume) traded on the São Paulo Stock Exchange (Bovespa: where ks refers to cost of equity capital calculated according to the Easton PEG ration (Easton, 2004; Hail & Leuz, 2005); BCDI refers to the score on the Brazilian Corporate Dis-closure Index; SIZE is the natural logarithm of total assets; MB measures the market-to-book ratio; BETA is the stock market beta; DE is the natural logarithm of the debt-to-equity ratio. ROA is return over operational assets calculated as the ratio between annual operating profits and non-current assets; GROWTH is the change in revenues from year t to year t - 1; EXTFINANCE is the ratio of foreign debt outstanding divid-ed by total long-term liabilities - this measure relates to amortized cost.

We also investigate whether the effect of disclosure on cost of equity is more pro-nounced for firms that receive less analyst coverage. We hypothesize that disclosure and analyst coverage act as substitutes, and the effect of disclosure on firms' cost of equity capital is less pronounced for firms that receive more attention from analysts. Our results confirm this hypothesis and show that the impact of disclosure on cost of equity is three times higher for firms with lower coverage. Our results are robust for controlling for cross-listing. An increa-se of 1 point in BCDI causes a decrease of 9 basis points in cost of equity for firms that receive more coverage from analysts and a decrease of 25 basis points for firms that receive less coverage. In addition, we examine the impact of ownership concen-tration on the relation between disclosure and cost of capital.

We also expect disclosure to be less important for firms with higher ownership concentration. Controlling shareholders have direct access to insider information and do not depend on public disclosures. The results confirm our expectations: an increase of 1 point in BCDI causes a decrease of 27 basis points in...

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