The Relationship Between The Quality Of Financial Reporting And The Cost Of Accounting

772 Words4 Pages
There is a significant incentive for companies to reduce information asymmetry via their cost of equity capital, namely that their market valuation could increase as investors better understand the risks and performance of the company. These two papers document the relationship between the quality of financial reporting and the cost of equity capital. Francis, LaFond, Olsson and Schipper (2004) use a number of measures to capture the quality of financial reports, whereas Artiach & Clarkson (2014) focus on just one measure of financial reporting quality. Notably they find different results for the one information quality measure they have in common, conservatism of financial statements. Francis et al (2004) find it has no relationship with…show more content…
In their robustness checks they firstly adjust the MPEG model for predictable forecast error and also use model generated earnings forecasts in place of analyst forecasts. Each paper has advantages and disadvantages in their estimation of cost of equity capital, Francis et al. (2004) uses two radically different models (one based on analysts’ forecasts, and one on PE ratios) which could lead to more robust results; but suffer from unenviable biases in their set. Conversely, Artiach and Clarkson (2014) have the luxury of choosing from an excellently ranked menu of cost of equity models thanks to Botosan (2011); however are limited by data in not being able to use the two most sophisticated, although do still have a more updated approach than Francis et al. (2004). The fundamental difference here is that Francis’ et al. (2004) primary results are driven by an analyst forecast model, whereas Artiach and Clarkson’s (2014) are driven by PE ratio model; as a result the results will be fundamentally different. Turning to their respective estimations of conservatism (as this is the one comparable measurement between the two papers), it is not surprising that each paper uses its own approach given the wide number of definitions and approaches available. However, both do use a firm-specific approach rather than cross-sectional. Francis et al. (2004) build their conservatism measure from reverse regressions using earnings as the dependent variable and returns
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