The impact of voluntary disclosure on cost of equity capital estimates in a temporal setting

This paper aims to investigate the association between the level of voluntary disclosure and cost of equity capital (COEC). Two disclosure indices following Botosan and Hail are developed and applied in an OLS regression on 95 listed companies from Austria, Germany, Sweden, and Denmark; the indices are defined according to the temporal context (historical, forward‐oriented) of information provided in annual reports. An expected negative relationship is found between the level of forward‐oriented information and COEC, and an unexpected positive relationship is found between the level of historical information and COEC. The sample is restricted to 95 listed companies in 2005. The disclosure index and COEC are not directly observable, and thus rely on constructs. Methodological drawbacks might include an endogeneity bias as well as investors not having homogeneous expectations and knowledge about capital markets. Traditional financial reporting models might not provide enough information in order to reduce information asymmetry and COEC. The findings provide insight into the impact of a required increased level of additional corporate information on corporate metrics, especially to standard setters and academic researchers as well as practitioners. The current research contributes in three ways: the application of a disclosure index on an international sample; the employment of a new approach to computing COEC, explicitly matching input variables to a pre‐specified estimation date; and the provision of evidence on the different impact of the temporal context of voluntarily disclosed information.