Disclosure Level and the Cost of Equity Capital-研究思想

Accounting Information,the Cost of Capital,andInvestors’WelfarePingyang Gao∗Yale School of Managementpingyang.gao@(A preliminary ments are welcome.Please do not circulate.)April2007∗I sincerely thank Rick Antle,John Geanakoplos,Dong Lou,Brian Mittendorf,Shyam Sunder,Jacob Thomas,Robert E.Verrecchia,Hongjun Yan,Frank Zhang and Yun Zhang for helpful comments.All errors are my own.1AbstractHow accounting information creates value for investors in stock markets is one of the most fundamental questions in accounting.The conventional wisdom is that high-quality accounting information benefits investors by reducing cost of capital.Intuitively appealing as it is,there are three unresolved issues.First,we do not have a theory for the link between investors’welfare and the cost of capital.Second,empirical evidence is disturbingly ambiguous about the relation between the cost of capital and information quality.Finally,theoretical researches have only demonstrated the cost of capital reduction effect of accounting information in some restrictive settings,mainly in pure exchange economies.In a more general setting,this paper reexamines these three issues and contradicts the conditional wisdom by making four observations.First,high-quality accounting information could increase the cost of capital.Second,both current and new investors’welfare could be improved or hurt by better accounting information.Third,there is no monotonic link between the impact of accounting information on the cost of capital and on investors’welfare.Finally,current and new investors have conflicting demands for information quality.These results help us redirect the empirical effort to document the value of accounting information and reevaluate the recent enthusiastic push for transparency.21IntroductionHow accounting information creates value for investors in stock markets is one of the most fundamental questions in accounting.Due to the difficulty in directly measuring investors’welfare,empiricists have chosen to explorefirst the link between information quality and the cost of capital,as an intermediate step to the ultimate understanding of the value of accounting information for investors.They have accumulated some ambiguous evidence that high-quality accounting information reduces the cost of capital(see Botosan,1997; Leuz and Verrecchia,2000;Botosan,Plumlee,and Xie,2004;Francis,LaFond,Olsson,and Schipper,2004,e.g.).Meanwhile,policy makers and standard setters have been basing their policy proposals on the cost of capital reduction effect of information quality for a long time (see Levitt,1998,e.g.).1Preceded by the empirical advancement and policy arguments,the theoretic researches in thisfield have shown how high-quality accounting information reduces the cost of capital in some restrictive settings(see O’Hara,2003;Easley and O’hara,2004; Hughes,Liu,and Liu,2007;Lambert,Leuz,and Verrecchia,2006,2007,e.g.).In a more general setting that admits both exchange and production economies,this paper explores the impact of information quality on the cost of capital and investors’welfare. Evaluating the welfare effect of a policy could be a controversial topic due to its scope. Thus,I start with clarifying the scope of the study that mainly follows the framework of the 1Arthur Levitt,the former chairman of SEC,repeated the remark in many occasions that“The truth is, high standards lower the cost of capital.And that’s a goal we share.”This remark seems to have motivated many of the subsequent academic researches.3previous researches in this area.First of all,I define information as an unbiased estimator of the true profitability of thefirm’s business,and define information quality as the precision of the estimator,so as to avoid the“incomparability problem”of information systems(see Blackwell,1953;Demski,1973,e.g.).As a result,“more information”is interchangeable with“better information”,“more precise information”or“more disclosure”in this paper.2 Second,I consider only two groups of investors who share risk through trading in stock markets.In particular,there are current investors who own afirm when the disclosure policy is chosen and new investors who buy thefirm’s stocks from current investors after the information comes out.Finally,I define the cost of capital as the expected return of the firm’s stocks when they are traded,and define welfare as investors’ex ante expected utility when the disclosure policy is set.Ex ante and ex post are relative to the disclosure.Within this scope,this paper constructs a general model in which thefirm,on behalf of current investors,has a certain level of endowed investment and is faced with a growth opportunity.It could install a costless information system(set the disclosure policy)which collects and gives out a publicly observable signal.After the signal is observed,thefirm decides on the level of new investment and then current investors sell their stocks to new investors.We will focus on how the disclosure policy affects the price at which current in-vestors sell the stocks,the cost of capital implied in the price,and current and new investors’ex ante expected utility.This model is general enough to include some models in the previ-2I also use“disclosure”and“information”interchangeably since any information is assumed to be publicly observable in this paper.See also footnote8and9about this assumption.4ous literature as its special cases by varying theflexibility of thefirm’s new investment.For example,we get the extensively used pure exchange model if we set theflexibility to be zero.The general model generates four observations.First,better accounting information could increase the cost of capital.There exists some region in which the cost of capital is increasing in information quality.One extreme example is a production economy with constant return to scale with respect to new investment.More generally,the cost of capital could increase in information quality when both the original precision and the information quality are modest and the prior profitability is relatively high.Second,both current and new investors’welfare could be either improved or hurt by high-quality accounting information. It hurts current investors when they are sufficiently risk averse relative to new investors and the fraction of the endowed investment is sufficiently large.It does harm to new investors’welfare when it reduces the amount of risk in the market for them to take through trading. Third,there is no monotonic link between the cost of capital effect and the welfare effect of accounting information.For example,in a pure exchange economy when current investors are sufficiently risk averse,high-quality information leads to a low cost of capital and low current and new investors’welfare.Finally,current and new investors have conflicting demands for information quality.The basic intuition of the results lies in the dual effects of accounting information.On the one hand,accounting information improves thefirm’s investment decisions.All other things being equal,better information results in higher welfare of current investors who own the business opportunity.More generally,in a single decision-maker setting in which information5does not change her decision environment,more information makes her weakly better offbecause she could always choose to ignore the information.3On the other hand,accounting information accelerates the resolution of risk.All things being equal,better information may destroy current investors’opportunities to share the risk with new investors.In a stock-market setting in which they have differential endowments,investors can not choose to ignore the disclosed information because it will be reflected in trading terms.Therefore, investors are not faced with the same decision environment any longer when they receive more information,and more information could be detrimental to their welfare.4The beneficial decision-making effect and the adverse risk-sharing effect of accounting information jointly determine the welfare effect of information quality.To gain better intuition,I then examine three special cases of the general model.Thefirst is the case of a pure exchange economy in which thefirm’s new investment does not respond to new information at all.Without the compounding decision-making effect,we are able to focus exclusively on how the adverse risk-sharing effect works.The risk of thefirm isfixed and shared between current and new investors through trading.More precise information allocates more risk to current investors and less to new investors and thus reduces the risk premium current investors need to pay new investors to take the risk,resulting in a low cost 3This beneficial decision-making effect of information is sometimes termed as the Blackwell effect,inhonor of David Blackwell for his seminal work Blackwell(1953).4This adverse risk-sharing effect of public information is also known as the Hirshleifer effect,after Jack Hirshleifer(1971)who started a vast literature on the social value of public information.6of capital.Moreover,current investors could be worse offif they are sufficiently risk averse relative to new investors,and new investors are always worse offbecause better information leaves less risk remaining in the market for them to take.The second special case occurs when thefirm does not have any endowed investment. This case minimizes the adverse risk-sharing effect and focuses us on the beneficial decision-making effect.On the one hand,more information results in a higher level of new investment and increased volatility,and the level effect dominates the variance effect.In other words, better information produces a more mean-variance efficient cashflow profile for thefirm. Therefore,current investors are better offwith more information.On the other hand,the variance of thefirm’s value is jointly determined by investment intensity and the risk of per-unit investment.While high-quality information increases the investment intensity,it reduces the risk associated with per-unit investment.It turns out that as information quality increases,the total risk of thefirm’s net cashflow increasesfirst,peaks at an interior point and then falls.Since new investors obtain trading surplus through contributing their risk tolerance,they are best served by the interior choice of information quality that maximizes the total risk of thefirm’s value.The third case is an economy with constant return to scale with respect to new investment. In such an economy,thefirm does not incur any adjustment cost for its new investment. Information becomes so useful for thefirm’s investment decisions that the level of thefirm’s cashflow increases much faster than the variance as the information quality improves.As a result,more information increases the cost of capital,although it boosts both current and7new investors’welfare at the same time.The intellectual antecedent of the paper is the discussion between Dye(2001)and Ver-recchia(2001)which highlights the adverse welfare effect of accounting information and mo-tivates me to explore the link between information quality and investors’welfare.5The main contribution of the paper is to demonstrate how accounting information creates value for in-vestors.It extends the previous literature by giving the conditions under which high-quality accounting information increases the cost of capital.It shows further that the often-used cost of capital is not equivalent to either current or new investors’welfare,and that high-quality accounting information improves investors’welfare only under some conditions.In addition, the paper also demonstrates the conflict between current and new investors over the choice of information quality.With these results,we may reassess the way accounting information adds value to investors in stock markets,reevaluate the enthusiastic push for transparency, and redirect the empirical effort to document the value of accounting information.One particularly interesting issue this study raises is the disturbing discrepancy between the cost of capital and either group of investors’welfare.Underlying many researches with policy implications(A short list includes disclosure regulations,voluntary disclosure polices, and corporate governance.)is the assumption that low cost of capital is a desirable goal for 5See also Holmstrom and Tirole(1993)and Dow and Rahi(2003)for the concern of the adverse welfare effect of public information in models in economics andfinance.Readers who are interested in the evolution of this topic are referred to Hirshleifer(1971);Marshall(1974);Ng(????);Hakansson,Kunkel,and Ohlson (1982);Green(1981);Verrecchia(1982);Schlee(2001);Eckwert and Zilcha(2001);Campbell(2004).8firms(current investors)and/or(new)investors.However,since the cost of capital is the expected return of stocks,it is not clear why either current or new investors should always benefit from the low expected returns.6On the one hand,firms can always lower the cost of capital by switching to low risk projects;on the other hand,stocks have higher expected returns than bonds,but this does not mean that new investors always prefer bonds to stocks. The disconnection between the cost of capital and investors’welfare serves as a caveat against using the cost of capital effect as a welfare effect measure.In addition,this paper contributes to the literature on the social value of public informa-tion by examining the impact of information quality in a production economy.Most papers in thisfield focus on pure exchange economies(see Hirshleifer,1971;Marshall,1974;Ng, ????;Hakansson,Kunkel,and Ohlson,1982;Orosel,1996;Schlee,2001,e.g.).Some early papers also paid sporadic attention to production economies.Hirshleifer(1971)gives an ex-ample of the value of public information in a production economy,Marshall(1974)discusses the importance of production,and Kunkel(1982)gives the sufficient conditions for public information to have positive social value in a general equilibrium model.More recently, Eckwert and Zilcha(2001,2003)reconsider the social value of public information in a pro-duction economy with an incomplete market;Lambert,Leuz,and Verrecchia(2007)examine the cost of capital effect of accounting information in a particular production economy.The model in this paper admits both pure exchange and production economies and allows us to 6Some papers define the cost of capital as the expected risk premium which is the unscaled version of the expected return when the risk free rate is normalized to be zero,see Easley and O’hara(2004).9understand simultaneously the adverse risk-sharing effect and the beneficial decision-making effect of accounting information.The rest of the paper is organized as follows.Section2develops a general model includ-ing production and exchange and studies the effect of information quality on the equilibrium price,the cost of capital,and current and new investors’welfare.Section3examines three special cases of the general model to glean better intuition and to illustrate the main obser-vations made in section2.Section4concludes.All proofs are placed in the appendix.2A General ModelThis section develops a general model admitting both pure exchange and production economies and examines the impact of information quality on the equilibrium price,the cost of capital, and investors’welfare.It makes four observations.First,more accounting information could increase the cost of capital.Second,both current and new investors’welfare could be im-proved or hurt by more accounting information.Third,there is no monotonic link between the impact of accounting information on the cost of capital and on investors’welfare.Finally, current and new investors have conflicting demands for information quality.2.1The ModelI only consider a single-firm economy with onefirm’s stocks and one risk free asset which acts as a numeraire and whose return is normalized to be zero.There are two groups of10investors,current and new investors,and three time nodes.7Current investors own thefirm and dictate all of thefirm’s decisions.8In particular,at t=0,thefirm has some endowed investment(ongoing business)and a costless information system which collects and gives out at t=1a publicly observable signal about thefirm’s future profitability.9The quality of the information system is the main variable of interest.Upon observing the signal at t=1, current investors choose a level of new investment and then sell thefirm’s ownership to new investors.10For ease of exposition,I adopt a simple variant of the overlapping generations model by assuming that new investors take over all the stocks and that current investors 7The previous literature usually juxtapose afirm and investors,and implicitly assume that minimizing the cost of capital is the objective of thefirm.To study the welfare effect of information on investors Ispecify current investors as the concrete owner of the abstractfirm.8I abstract from the agency problems between investors and thefirm’s manager in order to focus on the effect of information on risk sharing and decision making.Alternatively,we could assume that the manager is paid by a constant wage and implements whatever decisions requested by thefirm’s current investors.Thus,thefirm and current investors are interchangeable in the context of making decisions for thefirm.9I assume that current investors can not manipulate or window-dress the signal.The disclosure of the signal occurs because it is mandated by the extensive disclosure regulations,because the unraveling process studied by Grossman(1981)is at work,or because new investors can infer the information from thefirm’sinvestment decisions.10I assume for convenience that thefirm adjusts the investment level after the disclosure but before current investors sell their stocks to new shareholders.However,as long as the trading takes place after the information is observed,the timing of the investment adjustment does not matter because current investors take all the benefit and cost associated with the revealed information in a competitive market.11exit the market after the trading.11I shall discuss in detail the overlapping generations assumption at the end of this subsection.At t=2,thefirm’s investment pays offand the firm is liquidated.Figure1chronicles the time line of events.F igure1T he T ime Line of Events -t=0T he firm isendowed withsome initial investment and aninformation system.t=1T he informationis publicly disclosed;T he firm adjusts its investment;Current investors sell the firm sownership to new investors.t=2Investment pays off;T he firm is liquidated;Investors consume.Both current and new investors have CARA utility functions,and their coefficients of risk tolerance areτc andτn,where the subscripts“c”and“n”represent“current investors”11The overlapping generations model is extensively used in accounting research to study the effect of information.See Dye(1988);Easley and O’hara(2004);Christensen and Demski(2005);Lambert,Leuz, and Verrecchia(2007)for examples.Dye(1988)explicitly models the tension between current and perspective investors with respect to earnings management,both Easley and O’hara(2004)’s and Lambert,Leuz,and Verrecchia(2007)’s settings could be considered as one in which thefirm(the representative of current investors)sells all thefirm’s stocks to new investors,and Christensen and Demski(2005)study the role of reporting standards in the trading in which a seller(current investors)sells a piece of risky asset to a buyer (new investors).12and“new investors”,respectively.Investors’prior expectation of the future profitability isR0which is nonnegative.The innovation of the future profitability(˜µ)has a normal priordistribution of N(0,1α).The signal(˜y)generated by the information system is an unbiasedestimator of˜µand takes the form˜y=˜µ+˜ ,where˜ is normally distributed as N(0,1β)and independent of˜µ.βis thus the quality of information and the level of public disclosure. According to Bayesian rule,the posterior distribution of˜µbased on the information y isN(E[˜µ|y],V ar[˜µ|y])where E[˜µ|y]=βα+βy and V ar[˜µ|y]=1α+β.In addition,the mass ofcurrent investors is normalized to be1,and new investors have a mass of N.The value(net cashflow)of thefirm derives from both ongoing business and new invest-ment and takes the following form.˜v=m(R0+˜µ)+k˜µ−c2k2(1)˜v is the stochastic net cashflow of thefirm at t=2if thefirm invests k units upon theobservation of the information.12Thefirst component of˜v,m(R0+˜µ),is the net cashflowfrom the m units of endowed investment;the second quadratic component,k˜µ−c2k2,is the 12The normality assumption of the future profitability˜µmakes it possible that the optimal investment level is negative.One interpretation of the negative investment is that thefirm is choosing between two markets(A and B)with perfectly negatively correlated profitability(see Leuz and Verrecchia,2005;Lambert,Leuz,and Verrecchia,2007,e.g.).When the information y is optimistic,thefirm enters market A with an investment level k;when y is pessimistic,thefirm chooses market B with an investment level-k.However,it does not change the main results of the paper if we impose a threshold profitability below which thefirm does not make any investment,but the math to deal with a truncated distribution becomes less instructive.13net cashflow from the k units of new investment.Not only intuitively appealing,this value function also combines a pure exchange economy and a production economy,and allows us to study a spectrum of economies with different degrees of responsiveness to new information by varying m and c.Both m and c are exogenous to the model and determined by market conditions and technology.m represents the fraction of the endowed investment in thefirm’s investment portfolio;c is the adjustment cost of new investment and reflects theflexibility of thefirm’s new investment.To a large extent,both c and m measure the responsiveness of thefirm’s value to new information,as we shall see soon in the next section.A discussion of the role some assumptions play in this study is in order before we pro-ceed to the analysis of the model.The major assumption is the overlapping generations structure.This structure implies both the motivation and timing of trading.On the one hand,trading occurs in the overlapping generations model due to extreme liquidity reasons. Because of the“no-trading theorem”,trading in stock markets in the framework of rational expectations is usually motivated by exogenous liquidity reasons.13In particular,Grossman and Stiglitz(1980)introduce noise(liquidity)traders whose demand for stocks is orthogonal to information,and Diamond and Verrecchia(1981)use private endowment shocks which are analogous to private liquidity shocks.The inter-generation reason for trading is another modeling device and an extreme case of liquidity reasons.On the other hand,as to the timing 13For more details about the“no-trading theorem”,see Aumann(1976);Milgrom and Stokey(1982); Samuelson(2004).14of trading,there could be three choices in the overlapping generations model:pre-disclosure, post-disclosure,and both.Since trading is motivated by exogenous liquidity reasons,it is reasonable to assume that the pre-disclosure trading could be separate from the post-disclosure one.14The separability allows this paper to focus on the post-disclosure trading without loss of generality.The results of the paper are robust to the case of admitting both the pre-and post-disclosure trading because the conflict between the adverse risk-sharing effect and the beneficial decision-making effect of information in the post-disclosure trading would be still at work.Moreover,besides the exogenous inter-generation argument,we can also justify the possibility of the post-disclosure trading by invoking market incompleteness. For example,investors have different exposure to non-tradable risk such as human capital risk.If the disclosure made by thefirm also changes investors’assessment of the covariance between thefirm’s fundamental value and their human capital,that is,if the content of the disclosure changes investors’need for a hedge,then investors may not rebalance their portfolios before the disclosure.This scenario becomes more likely when the upcoming dis-closure can affect thefirm’s investment decisions.In addition,empirically,we observe huge abnormal trading volume after both scheduled and unscheduled corporate announcements (see Chae,2005,e.g.),showing the relevance of the post-disclosure trading in reality.With these caveats and justifications,I cautiously proceed with the assumption that we can focus 14Otherwise,investors would have both hedge and speculative demand in the pre-disclosure trading,usually resulting in the loss of a closed-form solution for their demand functions even in a pure exchange economy (see Grundy and McNichols,1989;Brown and Jennings,1989;Allen,Morris,and Shin,2006,e.g).15on the post-disclosure trading without loss of much generality.Two other assumptions which simplify the analysis drastically are well justified due to the recent progress in the literature(see Easley and O’hara,2004;Hughes,Liu,and Liu, 2007;Lambert,Leuz,and Verrecchia,2006,2007,e.g.).First,the analysis abstracts from information asymmetry between current and new mbert,Leuz,and Verrec-chia(2006)shows that in models of perfect competition,what affects the cost of capital is investors’average information precision,not the degree of information asymmetry among in-vestors per se.Since I adopt the perfect competition framework and consider only exogenous public information,the abstraction does not incur any loss of generality.Second,although I only study a single-firm economy,the analysis proves to be robust to diversification in a multi-firm economy,thanks to Lambert,Leuz,and Verrecchia(2007).On the one hand,we can interpret the variance of thefirm’s cashflow used in this study as the covariance of the firm’s cashflow with the sum of all the cashflows in the market.The Bayesian update rule for covariance is similar to that for variance,and thus most proofs can go through.On the other hand,the effect of the idiosyncratic information can not be diversified away when the information changes the cashflow generating process.Therefore,focusing on a single-firm economy is without loss of generality,too.162.2The Cost of Capital Effect of Information QualityIn this and next subsections,I solve the general model for the ex post equilibrium price,the cost of capital,and investor’s ex ante expected utility.Then,I conduct comparative statics to study the effect of information quality on these metrics.For expositional ease,I assume the all the parameters of the model are well defined.In particular,both the adjustment cost c and the fraction of the endowed investment m are positive and bounded.I use backward induction to solve the model in four steps.First,I solve for the trading equilibrium at t=1in which new investors determine their demand for thefirm’s stocks and thus determine the trading price,after they have observed the information y and thefirm’s investment k.Second,anticipating the equilibrium price,current investors choose an optimal investment level after observing the information y.Third,I calculate the average ex post price and the cost of capital,and then examine the impact of information quality on them. Finally,I solve for the ex ante expected utility of both current and new investors,and study the impact of information quality on them.Thefirst step is to solve for the trading equilibrium,given thefirm’s information quality β,the observation of the information y and thefirm’s new investment level k.Lemma1 summarizes the trading equilibrium.17。

公司理财期末重点总结C 1Corporate Finance addresses the following three questions:1.What long-term investments should the firm choose? Capital Budgeting(资本预算)2.How should the firm raise funds for the selected investments? Capital Structure(资本结构)3.How should short-term assets be managed and financed? Working Capital Management(营运资本)Capital Budgeting: The process of planning and managing a firm’s long-term investments is called capital budgeting. Capital Structure: A firm’s capital structure (or financial structure) is the specific mixture of long-term debt and equity the firm uses to finance its operations.Working Capital Management: The term working capital refers to firm’s short-tern assets and its short-term liabilities. Managing the firm’s working capital is a day-to-day activity that ensures that the firm has sufficient resources to continue its operations and avoid costly interruptions.Sole Proprietorship: A sole proprietorship is a business owned by one person. The owner can keep all the profit. However, he has unlimited liability for business debts.Partnership: A partnership is similar to a proprietorship, except that there are two or more owners.General Partnership: All the partners share in gains or losses, and all have unlimited liability for all partnership debts, not just some particular share. Limited Partnership: One or more general partners will run the business and have unlimited liability, but there will be one or more limited partners who will not actively participate in the business.Primary disadvantages: 1.unlimited liability for business debt on the part of the owners 2.limited life of the business3.difficulty of transferring ownership Corporation: A corporation is a legal person separate and distinct from its owners. Disadvantages: Double taxation, separation of ownership and control rights. The goal of financial management is to maximize the current value per share of the existing stock.A more general goal：Maximize the market value of the existing owner’s equity. Agency relationship：Principal hires an agent to represent his/her interest Agency problem：Separation of ownership and control rights, Conflict of interest between principal and agent.Agency costs：refers to the costs of the conflict of interest between stockholders and management.C2Goal: cash is kingThe goal of financial management：is to maximize the market value of the stock The balance sheet equation (Balance sheet identity)Assets = liabilities + shareholder’s equityThe value of liabilities and shareholder’s equity= current liabilities + long term debt + shareholder’s equityNet working capital净营运资本=Current assets – current liabilitiesLiquidity流动性: refers to the speed and ease which an asset can be converted to cash.the more liquid business is, the less likely it is to experience financial distress. Debt versus Equity（负债与权益）: Shareholders’ equity= Assets - Liabilities Market value VS book valueBook value账⾯价值：under Generally Accepted Accounting Principles（公认会计原则GAAP），audited financial statements generally show assets at historical cost。

政治关联英文文献索引1.T he stock market implication of political connections: evidence from firms' dividend policy 政治关系的证券市场含义：来自公司股利政策的证据（Cao et al.2012）2.C orporate ownership, corporate governance reform and timeliness of earnings: Malaysian evidence公司所有权、公司治理改革与盈余及时性：马来西亚的证据3.P olitical connections, bank deposits, and formal deposit insurance: Evidence from an emerging economy政治关系、银行存款与正式的存款保险：来自新兴经济体的证据（June 18, 2013）4.P olitical connections and investment efficiency: Evidence from Chinese listed private firms 政治关系与投资效率：来自中国民营上市公司的证据（August 27, 2013）5.T he Political Determinants of the Cost of Equity: Evidence from Newly Privatized Firms权益资本成本的政治因素：来自刚刚私有化公司的证据（August 2008）6.C ronyism and Capital Controls: Evidence from Malaysia任人唯亲与资本管制：来自马来西亚的证据7.Capital Structure and Political Patronage: Evidence from China资本结构与政治庇护：来自中国的证据8.P olitical Connection and Government Patronage：Evidence from Chinese Manufacturing Firms政治关联与政府赞助：来自中国制造业企业的证据9.P olitical Connections and Firm V alue: Evidence from the Regression Discontinuity Design of Close Gubernatorial Elections政治关联与公司价值：来自临近州长竞选的不连续回归设计的证据10.How does state ownership affect tax avoidance? Evidence from China国家所有权如何影响避税？来自中国的证据11.Do Strong Corporate Governance Firms Still Require Political Connection? And Vice V ersa公司治理强的企业仍然需要政治关系吗？反之亦然12.Political Connections and Preferential Access to Finance: The Role of Campaign Contributions政治关联与优先获得融资：竞选捐款的作用13.Political Connections and the Cost of Equity Capital政治关联与权益资本成本（Boubakri et al. January 2012）14.The Impact of Political Connections on Firms' Operation Performance and Financing Decisions政治关联对公司经营业绩及融资决策的影响（Boubakri et al. November 29, 2011）15.Political Connections and the Cost of Bank Loans政治关系与银行贷款成本（Houston et al. February 15, 2012）16.Politicians and the IPO Decision: The impact of impending political promotions on IPO activity in China政治家与IPO决策：即将来临的政治晋升对中国IPO活动的影响17.Accounting Conservatism and Bankruptcy Risk会计稳健性与破产风险（Biddle et al. October 7, 2013）18.Accounting Conservatism and its Effects on Financial Reporting Quality:A Review of the Literature会计稳健性及其对影响财务报告质量：文献综述（September 9, 2011）19.Conservatism, Disclosure and the Cost of Equity Capital稳健性、披露与权益资本成本（Artiach et al. January 2012）20.Does Access to Finance Lower Firms’ Cost of Capital? Empirical Evidence from International Manufacturing Data获得融资降低了企业的资本成本吗？来自国际制造业数据的实证证据21.Political connections, founding family ownership and leverage decision of privately owned firms政治关联、创始家族所有权与私有企业杠杆决策22.The Impact of Political Connectedness on Firm V alue and Corporate Policies: Evidence from Citizens United政治关系对公司价值及公司政策的影响：来自美国公民的证据23.The Quality of Accounting Information in Politically Connected Firms政治关联企业的会计信息质量24.The political economy of corporate governance, cost of equity, and earnings quality: evidence from newly privatized firms公司治理的政治经济、权益资本成本与盈余质量：来自刚刚私有化公司的证据25.Do Political Connections Help Firms Gain Access to Bank Credit in Vietnam政治关系帮助越南企业获得银行信贷吗？26.Firm performance effects of nurturing political connections through campaign contributions通过竞选捐款培育政治关系的公司绩效效应27.The Chrysler Effect: The Impact of the Chrysler Bailout on Borrowing Cost克莱斯勒效应：克莱斯勒救助对借贷成本的影响28.Politically connected firms in Poland and their access to bank financing波兰的政治关联企业及他们获得银行融资29.Political Connections and Corporate Bailouts政治关系与企业救助30.The characteristics of politically connected firms政治关联企业的特征31.Rent Seeking Incentives, Political Connections and Organizational Structure: Empirical Evidence from Listed Family Firms in China寻租动机、政治关系与组织结构：来自中国上市家族企业的经验证据32.The V alue of Connections In Turbulent Times: Evidence from the United States在动荡的时代关系价值：来自美国的证据33.Malaysian Capital Controls: Macroeconomics and Institutions马来西亚的资本控制：宏观经济和制度34.Rent Seeking and Corporate Finance: Evidence from Corruption Cases寻租与公司融资：腐败案件的证据35.Political Motivation, Over-investment and Firm Performance政治动机、过度投资与公司绩效36.Political connections and earnings quality: evidence from malaysia政治关系与盈余质量——来自马来西亚的证据37.Political Connections and Minority-Shareholder Protection: Evidence from Securities-Market Regulation in China政治关系与少数股东保护：来自中国证券市场监管的经验证据38.Accounting Conservatism, Corporate Governance and Political Influence: Evidence from Malaysia会计稳健性、公司治理与政治影响：来自马来西亚的证据39.Internationalization and Capital Structure: Evidence from Malaysian Manufacturing Firm国际化和资本结构：来自马来西亚制造企业的证据40.Firm size and corporate financial leverage choice in a developing economy Evidence from Nigeria企业规模和企业财务杠杆的选择：来自尼日利亚发展中经济的证据41.Ownership and the V alue of Political Connections: Evidence from China所有权和政治关系的价值：来自中国的证据42.Ownership Types, CEO and Chairman Political Connections, and Long-run Post-IPO Performance: Evidence from China所有权类型、CEO和董事长的政治联系与IPO后长期绩效：来自中国的证据43.Theoretical Investigation on Determinants of Government-Linked Companies Capital Structure关于政府联系公司资本结构的影响因素的理论研究44.Auditor Choice in Privatized Firms: Empirical Evidence on the Role of State and Foreign Owners私有化企业的审计师选择：来自国家和外国所有者作用的经验证据45.The Political Economy of Residual State Ownership in Privatized Firms: Evidence from Emerging Markets私有化企业中剩余政府所有权的政治经济：从新兴市场的证据46.Political Connections and the Process of Going Public: Evidence from China政治关系和上市的过程：来自中国的证据47.Public policy, political connections,and effective tax rates: Longitudinal evidence from Malaysia公共政策、政治关系与有效税率：来自马来西亚的纵向证据48.Why do countries adopt International Financial Reporting Standards为什么各国采用国际财务报告准则49.Political Relationships, Global Financing and Corporate Transparency政治关系、全球融资与公司透明度50.Politically Connected CEOs and Corporate Outcomes: Evidence from France政治关系的首席执行官和公司的结果：来自法国的证据51.Corporate Lobbying, Political Connections, and the Bailout of Banks公司游说、政治关系与银行救助52.Corruption, Political Connections, and Municipal Finance腐败、政治关系与城市金融53.Political connections, corporate governance and preferential bank loans政治联系、公司治理与优惠的银行贷款54.Politically connected firms: an international event study政治关系的企业：一个国际事件研究55.Politicians at work：The private returns and social costs of political connections政客们在工作：私人收益与政治关系的社会成本56.Political Connection, Financing Frictions, and Corporate Investment: Evidence from Chinese Listed Family Firms政治联系、融资摩擦与企业投资——来自中国上市家族企业的证据57.The Role Political Connections Play in Access to Finance:Evidence from Cross-Listing 政治关系在获得融资中发挥的作用：来自交叉上市的证据58.Auditor Choice in Politically Connected Firms政治关联公司的审计师选择59.Financial liberalization, financing constraints and political connection: evidence from Chinese firms金融自由化、融资约束与政治联系：来自中国上市公司的经验证据60.Effects of Financial Liberalization and Political Connection on Listed Chinese Firms' Financing Constraints金融自由化与政治关系对中国上市公司融资约束的影响61.Auditor Tenure, Non-Audit Services and Earnings Conservatism: Evidence from Malaysia审计任期，非审计服务与盈余稳健性——来自马来西亚的证据62.Political Connections of Newly Privatized Firms新私有化企业的政治关系63.Social network, entertainment expenditures and bank lending decisions: Evidence from China’s nonSOE firms社会网络、娱乐支出和银行贷款决策：来自中国非国有企业的证据64.Bank connection, corruption and collateral in China银行联系、腐败和担保：来自中国的证据65.Red Capitalists: Political Connections and Firm Performance in China红色资本家：政治关系与中国公司的业绩66.Political connections, bank deposits, and formal deposit insurance: Evidence from an emerging economy政治关系、银行存款与正式存款保险：来自新兴经济体的证据67.Executive’s former banking experience, entertainment expenditures and bank lending decisions: Evidence from China’s non-SOE firms执行官以前的银行业经验、娱乐支出与银行信贷决策：来自中国的非国有企业的证据68.The effect of political connections on the level and value of cash holdings: International evidence政治关联对现金持有水平及其价值的影响：国际证据69.The Effect of Political Influence and Corporate Transparency on Firm Performance: Empirical Evidence From Indonesian Listed Companies政治影响力与企业透明度对企业绩效的影响：来自印尼股票上市公司的经验证据70.Going Public Process and Political Connections: Evidence from an Emerging Market上市过程与政治联系：来自新兴市场的证据71.Do IPOs Reduce Firms’ Cost of Bank Loans? Evidence from ChinaIPO降低企业的银行贷款成本？来自中国的证据72.Public governance and corporate finance: Evidence from corruption cases公共治理与公司融资：腐败案件的证据73.Dividends, ownership structure and board governance on firm value: empirical evidence from malaysian listed firms股利、股权结构和董事会治理与公司价值：来自马来西亚上市公司的经验证据74.Management Quality and the Cost of Debt: Does Management Matter to Lenders管理质量和债务成本：管理对贷款人重要吗75.Do Educational Ties with Politicians Increase Agency Problems教育与政客联结增加代理问题吗76.Red Capitalists: Political Connections and the Growth and survival of Start-up Companies in China红色资本家：政治关系、成长和中国创业企业的生存77.The Impact of Legal and Political Institutions on Equity Trading Costs: A Cross-Country Analysis法律和政治制度对股票交易成本的影响：一个跨国家分析78.Expropriation of minority shareholders in politically connected firms政治关系企业中侵占小股东利益79.The Political Economy of Residual State Ownership in Privatized Firms: Evidence from Emerging Markets私有化企业中剩余政府所有权的政治经济：来自新兴市场的证据80.Does Financial Globalization Discipline Politically Connected Firms金融全球化约束政治关联的企业吗81.Audit fees in malaysia: does corporate governance matter马来西亚的审计费用：公司治理重要吗82.The Costs of Political Influence: Firm-Level Evidence from Developing Countries政治影响的成本：来自发展中国家的企业层面的证据83.Corporate social responsibility disclosure and its relation on institutional ownership企业社会责任披露及其与机构所有权的关系84.Political Connections and the Process of Going Public: Evidence from China政治关系和上市过程：来自中国的证据85.The Economic Benefits of Political Connections in Late Victorian Britain英国维多利亚时代后期政治关系的经济效益86.Corporate Cash Holdings, Board Structure, and Ownership Concentration: Evidence from Singapore企业现金持有量、董事会结构与股权集中度：来自新加坡的证据Political Uncertainty and Corporate Investment Cycles政治的不确定性与企业投资周期The Chinese Corporate Savings Puzzle: A Firm-Level Cross-Country Perspective中国公司储蓄的困惑：一个企业层面跨国家的视角Chinese firms’ political connection, ownership, and financing constraints中国企业的政治联系，、所有权与融资约束Political Relations and Overseas Stock Exchange Listing: Evidence from Chinese StateownedEnterprises政治关系和海外证券交易所上市：来自中国国有企业的证据Determinants and Effects of Corporate Lobbying企业游说的影响因素及影响Tunneling or Propping: Evidence from Connected Transactions in China隧道还是支持：来自中国关联交易的证据Sheltering Corporate Assets from Political Extraction保护公司资产从政治的提取Bank Power and Cash Holdings: Evidence from Japan银行权利与现金持有：来自日本的证据OLIGARCHIC FAMIL Y CONTROL, SOCIAL ECONOMIC OUTCOMES, AND THE QUALITY OF GOVERNMENT寡头的家族控制、社会的经济成果与政府质量Government Ownership and Corporate Governance: Evidence from the EU政府所有权与公司治理：来自欧盟的证据The Political Economy of Financial Systems金融体系的政治经济Escaping Political Extraction: Political Participation, Institutions, and Cash Holdings in China逃避政治的提取：政治参与、制度与中国的现金持有The value of local political connections in a low-corruption environment地方政治关系在低的腐败环境中的价值Retained State Shareholding in Chinese PLCs: Does Government Ownership Reduce Corporate Value中国上市公司保留的国有股：政府所有权降低企业价值吗Ownership Structure, Institutional Development, and Political Extraction: Evidence from China所有权结构、制度发展与政治提取：来自中国的证据How Do Agency Costs Affect Firm Value? Evidence from China代理成本如何影响公司价值吗？来自中国的证据Corporate Lobbying and Financial Performance公司游说与财务绩效Rights Issues in China as Evidence for the Existence of Two Types of Agency Problems中国人权问题作为两类代理问题存在的证据Auditor Choice in Politically Connected Firms政治关联公司的审计师选择（Journal of Accounting Research，V ol. 52 No. 1 March 2014）Transparency in Politically Connected Firms: Evidence from Private Sector Firms in China政治关联公司的透明度：来自中国私营公司的证据Capital Structure and Political Patronage: Evidence from China资本结构与政治赞助：来自中国的证据Competitive Pressure and Corporate Policies竞争压力与公司政策Political Capital and Moral Hazard1政治资本与道德风险The Effects of Government Quality on Corporate Cash Holdings政府质量对企业现金持有量的影响Corruption in Developing Countries腐败在发展中国家Large investors, capital expenditures, and firm value: Evidence from the Chinese stock market大投资者、资本支出与企业价值：来自中国证券市场的经验证据Firm Investment & Credit Constraints in India, 1997 – 2006: A stochastic frontier approach印度公司的投资与信贷约束，1997–2006：随机前沿方法State Ownership, Soft-Budget Constraint and Cash Holdings:Evidence from China’s Privatized Firms政府所有权、软预算约束与现金持有：来自中国私有化企业的证据Why Do Firms Hold Less Cash为什么公司持有更少的现金Directors’ Political Conn ections and Compliance with Board of Directors Regulations: The Case of S&P/Tsx 300 Companies董事会的政治关系和董事会遵守：标准普尔/ TSX 300公司为例Political Connection and Firm Value政治联系与企业价值The Impact of Political Connectedness on Firm Value and Corporate Policies: Evidence from Citizens United政治关系对公司价值和公司政策的影响：来自美国公民的证据The Impact of Political Connectedness on Cash Holdings: Evidence from Citizens United政治关系对现金持有的影响：来自美国公民的证据Political power and blood-related firm performance政治权力与有血缘关系的公司绩效Politically-Connecte d Boards and the Structure of Chief Executive Officer Compensation Packages in Taiwanese Firms政治关联董事会和台湾公司CEO薪酬结构Government Ownership and Agency Problems in Equity Offerings in China政府所有权与中国股票发行的代理问题Political Uncertainty and Accounting Conservatism: Evidence from the U.S. Presidential Election Cycle 政治不确定性与会计稳健性：来自美国总统选举周期的证据Effect of political uncertainty and corporate investment cycles in Nepal政治不确定性对尼泊尔企业投资周期的影响CEOs’ Connectedness, Social Capital, and Corporate InvestmentCEO关联、社会资本与企业投资Sovereign Wealth Funds and Politically Connected Firms主权财富基金与政治关联企业Political reforms and family-related firm performance政治改革与家族企业绩效Family connections in a low-corruption environment: Evidence from revised municipality borders在一个较低的腐败环境中家族联系：来自修订市边界的证据Does Political Uncertainty Affect Capital Structure Choices政治不确定性影响资本结构的选择吗Corporate Political Connections and Tax Aggressiveness企业政治关系与税收激进性Executive Compensation vis-à-vis Firm Performance: Identifying Future Research Agenda经理薪酬相对于公司绩效：识别未来的研究议程，Does Organizational-level Affiliation of Internal Audit Influence Corporate Risk-Taking? -Evidences from Chinese Listed Companies内部审计风险水平影响企业组织的联系吗？——来自中国股票上市公司的证据Principal-Principal Conflicts under Weak Institutions: A Study of Corporate Takeovers in China较弱制度下的委托代理冲突：中国公司并购的研究Earnings Management Practices Between Government Linked and Chinese Family Linked Companies 政府关联公司与中国家族关联企业之间的盈余管理实践Managerial Agency Costs of Socialistic Internal Capital Markets: Empirical Evidence from China社会主义内部资本市场的经理人代理成本：来自中国的经验证据Firm Size, Sovereign Governance, and Value Creation公司规模、主权治理与价值创造Bank firm relationship and firm performance under a state-owned bank system: evidence from China银企关系与企业国有银行制度下的绩效：来自中国的证据Excess control rights and corporate acquisitions超额控制权与公司并购Bank loan and the agency costs of debt in indonesia; free cash flows and managerial perks perspective 银行贷款和印度尼西亚债务的代理成本：自由现金流与管理津贴的视角CEO Compensation and Political ConnectednessCEO薪酬与政治关联Enterprises, Political Connections and Public Procurement at a Time of Landmark企业、政治关系与公共采购：一次具有里程碑意义的The Political Determinants of the Cost of Equity: Evidence from Newly Privatized Firms股权成本的政治因素：来自刚刚私有化的公司的证据Managerial Attributes and Executive Compensation管理者特征与高管薪酬An Empirical Investigation into the Political Economy of the Firm in a Globalizing World Economy: How Domestic Political Connections Affect Cross-listing Choices实证研究在全球化的世界经济的坚定的政治经济：国内政治关系如何影响交叉上市的选择Capital Markets and Capital Allocation:Implications for Economies of Transition资本市场与资本配置：经济转型的影响Responding to Financial Crisis: The Rise of State Ownership and Implications for Firm Performance应对金融危机：国家所有权上升对企业绩效的影响Influential ownership and capital structure有影响力的所有权与资本结构The Strategic Role Firms’ Political Connections Play in Access to Finance: Coercion of Domestic Banks or Implicit Property Rights Protections企业政治关系在获得融资中的战略作用：国内银行或隐含产权保护的强制手段Corporate Bailouts: the Role of Costly External Finance and Operating Performance企业救助：昂贵的外部融资的作用与经营绩效Do Political Connections Matter? Empirical Evidence from Listed Firms in Pakistan政治联系重要吗？来自巴基斯坦上市公司的经验证据Tycoons Turned Leaders: Market Valuation of Political Connections富豪转身领导：政治联系的市场价值Political Contributions and CEO Pay政治捐款和首席执行官工资Valuing Changes in Political Networks: Evidence from Campaign Contributions to Close Congressional 重视政治网络的变化：从运动的贡献接近国会的证据Corruption in state asset sales – Evidence from China国有资产销售中的腐败–来自中国的证据Investor Protection and Interest Group Politics投资者保护与利益集团政治Privatization, Large Shareholders’ In centive to Expropriate, and Firm Performance私有化、大股东掠夺激励与公司绩效Advances in Measuring Corruption in the Field腐败测量领域的进展Macroeconomic Conditions and the Puzzles of Credit Spreads and Capital Structure宏观经济条件、信用利差的困惑与资本结构Family Ownership and the Cost of Under Diversification家族所有权与多元化的成本Political Geography and Corporate Political Strategy政治地理学与企业政治策略Evidence on the existence and impact of corruption in state asset sales in China中国国有资产出售中腐败现象的存在及影响的证据Stock versus cash dividends: signaling or catering股票与现金股利：信号或宴会The impact of corruption on state asset sales – Evidence from China腐败对国有资产出售的影响-来自中国的证据Executive Compensation and CEO Equity Incentives in China’s Listed Firms高管薪酬与中国上市公司首席执行官的股权激励Political Constraints, Organizational Forms, and Privatization Performance:Evidence from China政治约束、组织形式与民营化绩效：来自中国的证据State Ownership, Political Institutions, and Stock Price Informativeness: Evidence from Privatization政府所有权、政治制度与股价信息含量：来自私有化的证据Corporate Governance in Emerging Markets: A Survey新兴市场的公司治理：文献综述Politically Connected Boards and Top Executive Pay In Chinese Listed Firms1.Political connection and leverage: Some Malaysian evidence2.Do political connections affect the role of independent audit committees and CEO Duality? Someevidence from Malaysian audit pricing3.Board, audit committee and restatement-induced class action lawsuits4.The Political Determinants of the Cost of Equity: Evidence from Newly Privatized Firms5.The impact of political connections on firms’ operating performance and financing decisionsernment Connections and Financial Constraints：Evidence from a Large Representative Sampleof Chinese Firms7.Listing approach, political favours and earnings quality: Evidence from Chinese family firms8.Political connections and tax-induced earnings management: evidence from China9.Ownership Concentration, State Ownership, and Effective Tax Rates: Evidence from China's ListedContext: European Evidence10.Impact of financial reporting quality on the implied cost of equity capital: Evidence from theMalaysian listed firms公允价值会计准则在新兴市场实施的挑战：来自中国采用国际财务报告准则的证据制度环境、政治关系与融资约束——来自中国民营企业的证据（March 1, 2012）政治关联、终极控制人性质与权益资本成本政治关联、盈余质量与权益资本成本政治联系、市场化进程与权益资本成本——来自中国民营上市公司的经验证据政府干预、政治关联与权益资本成本民营企业的政治关联能降低权益资本成本吗。

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DOI:10.1111/j.1475-679X.2006.00214.xJournal of Accounting ResearchVol.44No.4September2006Printed in U.S.A.Taxes,Leverage,and the Costof Equity CapitalD A N D H A L I W A L,∗S H A NE H E I T Z M A N,†O L I V E R Z H E N L I‡Received25February2005;accepted10January2006ABSTRACTWe examine the associations among leverage,corporate and investor level taxes,and thefirm’s implied cost of equity capital.Expanding on Modigliani and Miller[1958,1963],the cost of equity capital can be expressed as a func-tion of leverage and corporate and investor level taxes.Based on this expres-sion,we predict that the cost of equity is increasing in leverage,and that corporate taxes mitigate this leverage-related risk premium,while the per-sonal tax disadvantage of debt increases this premium.We empirically test these predictions using implied cost of equity estimates and proxies for the firm’s corporate tax rate and the personal tax disadvantage of debt.Our results suggest that the equity risk premium associated with leverage is decreasing in the corporate tax benefit from debt.Wefind some evidence that the equity risk premium from leverage is increasing in the personal tax penalty associated with debt.1.IntroductionIn this paper,we examine the effect of taxes and leverage on afirm’s cost of equity capital.A long stream of literature has sought to understand how the corporate and investor level tax consequences of debt affectfirm value and the cost of capital.Modigliani and Miller[1958]demonstrate that∗University of Arizona and University of Auckland;†University of Rochester;‡University of Notre Dame.We thank workshop participants at Purdue University,Northwestern University, Stanford University,and the University of Washington as well as George Foster,David Larcker, and an anonymous referee for helpful comments and suggestions.We thank John Graham for providing the simulated tax rates used in this study and I/B/E/S for providing analyst forecast data.691Copyright C ,University of Chicago on behalf of the Institute of Professional Accounting,2006692D.DHALIWAL,S.HEITZMAN,AND O.Z.LIin the absence of taxes and transaction costs,firm value and the weighted average cost of capital are independent of capital structure.Holding the average cost of capital constant,they show that the cost of equity contains a financial risk premium that is positively related to thefirm’s leverage.With corporate taxes,Modigliani and Miller[1963]establish that the tax benefit provided by the interest expense deduction increasesfirm value and reduces the equity risk premium from ler[1977]introduces the effect of personal level taxes into the analysis.He argues that individual investors demand a higher pretax return on debt to compensate for the personal tax on interest income.In equilibrium,the investor level tax disadvantage of debt can completely offset the corporate tax benefit,making capital struc-ture irrelevant.DeAngelo and Masulis[1980]argue that there is still a net tax benefit to debt,but show that in the presence of nondebt tax shields, thefirm may not realize the full benefit of the interest expense deduction. In equilibrium,eachfirm equates the expected tax benefit of an additional dollar of debt with the expected tax cost to investors.Numerous studies,including MacKie-Mason[1990],Dhaliwal,Trezevant, and Wang[1992],and Graham[1999],examine the effect of corporate and investor level taxes onfirms’financial leverage and incrementalfinanc-ing decisions.In general,theirfindings suggest thatfirms’capital structure choices correlate with corporate and investor level taxes in a predicted man-ner.These studies presume that economic considerations drive managers’capital structure decisions,but do not provide direct evidence that the tax implications of debtfinancing are reflected infirm value or the cost of eq-uity capital.Fama and French[1998]investigate whether leverage increases firm value consistent with the existence of a tax benefit to debt,butfind the opposite effect and conclude that nontax explanations dominate.They also argue,“In short,good estimates of how the tax treatment of dividends and debt affects the cost of capital andfirm value are a high priority for research...”(Fama and French[1998,p.819]).In this paper,we use esti-mates of the ex ante expected return implied by accounting-based valuation models to investigate whether the tax consequences of debt affect thefirm’s cost of equity capital.Recent developments in the literature on accounting-based valuation models have expanded the available options for estimating thefirm’s ex ante cost of equity capital.These approaches utilize variations on the resid-ual income valuation model(Ohlson[1995])to infer investors’expected return from stock price,dividends,book value of equity,and forecasted fu-ture earnings.Numerous recent studies exploit these implied cost of equity capital estimates to address a broad range of questions in accounting and finance.1If tax consequences affect the price investors are willing to pay for a given security,then the discount rate implied by the relation between1See,for example,Ashbaugh-Skaife,Collins,and LaFond[2004],Botosan[1997],Botosan and Plumlee[2002],Hail and Leuz[2006],Francis et al.[2004],Dhaliwal et al.[2005].TAXES AND LEVERAGE693 market price and expected future earnings should capture any tax-related premium demanded by equity investors.Modigliani and Miller[1958,1963]show that the cost of equity capital contains a risk premium that is increasing in leverage(i.e.,the equity risk premium from leverage).They further show that the equity risk premium from leverage is a function of corporate level taxes.We expand this expres-sion to incorporate the effect of investor level taxes.2Comparative statics indicate that corporate level taxes reduce thefirm’s equity risk premium from leverage,consistent with the corporate tax benefit of debt accruing to equity holders.In contrast,the personal tax penalty associated with debt increases this premium,which is consistent with equity investors demanding a higher return for a given amount of leverage as the relative cost of debt financing increases.To empirically test these predictions,we regress thefirm’s implied cost of equity capital on leverage and the interactions between leverage and the firm’s estimated marginal tax rate,and between leverage and the personal tax penalty associated with debt.We use the simulated marginal corporate tax rate beforefinancing described in Graham,Lemmon,and Schallheim [1998]to estimate thefirm’s tax benefit from debt.We use the top individual statutory rate on ordinary income as our proxy for the investor level tax rate on debt income and a weighted-average of individual tax rates on dividends and capital gains to proxy for the investor level tax rate on equity income. Based on the estimated investor level tax rates on debt and equity income, we construct a proxy for the personal tax penalty associated with debt that is increasing in the extent to which the investor level tax on debt income exceeds the investor level tax on equity.The empirical results generally support our predictions.First,the implied cost of equity capital is increasing in leverage,consistent with Modigliani and Miller[1958].Second,the equity risk premium from leverage is decreasing in thefirm’s estimated marginal tax rate beforefinancing.This result sug-gests that the tax benefit from debt reduces the cost of equity and increases market value.Third,the personal tax penalty associated with debt increases the equity risk premium from leverage in a pooled regression,but not in cross-sectional regressions.Overall,the results provide support for the hy-pothesis that the corporate tax benefit from debt reduces the equity risk premium from leverage,while the effect of personal taxes on this leverage-related premium appears to be driven by temporal variation in statutory tax rates.This paper is related to a long stream of literature that investigates the ef-fect of corporate and investor level taxes on equity value and thefirm’s cost of capital.Much of this literature focuses on the effect of dividend taxation on the cost of equity capital andfirm value using ex post realized returns(e.g., Dhaliwal,Li,and Trezevant[2003],Litzenberger and Ramaswamy[1979])2See Taggart[1991]for a similar expression.694D.DHALIWAL,S.HEITZMAN,AND O.Z.LIor event studies surrounding changes in statutory tax rates(e.g.,Ayers, Cloyd,and Robinson[2002],Lang and Shackelford[2000]).3A closely related paper by Dhaliwal et al.[2005]uses ex ante cost of equity estimates implied by accounting-based valuation models to test whether the effect of dividend taxes is capitalized in expected returns.Similar to Dhaliwal et al. [2005],we motivate the paper with a basic valuation model that links taxes with pretax required returns and test whether the empirical evidence is consistent with the theoretical predictions of the model.However,Dhaliwal et al.[2005]focus on the cost of equity capital implications of investor level taxes associated with afirm’s payout policy decisions.In contrast,we focus on the cost of equity effects of corporate and investor level taxes associated with thefirm’sfinancing decisions.We contribute to the literature by usingfirms’ex ante cost of equity implied by accounting-based valuation models to address the longstanding question of whether the tax consequences of leverage affectfirm value and the cost of equity.Generally,ourfindings suggest that the tax implications of capital structure decisions affect thefirm’s cost of equity in the predicted manner.This triangulates with prior research that shows that the capital structure decision is related to thefirm-specific magnitude of the corporate tax benefit of debt and the personal tax penalty associated with debt.The remainder of the paper is organized as follows.Section2develops the theory and hypotheses.Section3discusses the empirical methodology and variable selection.Section4presents the empirical results and sensitivity analyses.Section5summarizes and concludes.2.Theory and Hypotheses Development2.1LEVERAGE,TAXES,AND THE COST OF EQUITY CAPITALThe results in Modigliani and Miller[1958,1963]can be expanded to demonstrate how leverage and corporate and investor level taxes affect the firm’s cost of equity capital(e.g.,Taggart[1991]).Consider twofirms with identical productive assets.The expected cashflows generated by these two firms,X,are identical.Firm U is an all equityfirm andfirm L has some debt in its capital structure.Assume that the corporate tax rate isτc,the personal level tax rate on equity income isτps,and the personal level tax rate on debt income isτpb.The total after-tax cashflow to capital providers of the levered firm,C L,isC L=(X−rB L)(1−τc)(1−τps)+rB L(1−τpb),(1) where B L is the market value of debt infirm L’s capital structure and r is the interest rate on the debt.Thefirst term of equation(1)is the after-tax cashflow to equity holders and the second term is the after-tax cashflow to debt holders.Equation(1)can be rewritten as3For a recent review of the literature on the effect of taxes on asset prices,see Shackelford and Shevlin[2001].TAXES AND LEVERAGE 695C L =X (1−τc )(1−τps )+r (1−τpb )B L1−(1−τc )(1−τps )1−τpb .(2)The first term of equation (2)represents the after-tax cash flow to the all-equity firm U and the second term represents the cash flow benefit of debt after considering both corporate and personal level taxes on equity and debt.If we capitalize the above cash flow stream using the appropriate after-tax discount rates on equity and debt income,we obtain the relation between the value of the levered firm L ,V L ,and the value of the unlevered firm U ,V U ,V L =V U + 1−(1−τc )(1−τps )1−τpbB L .(3)Thus,the value of the levered firm is equal to the value of an all-equity firm plus the gain from leverage (Miller [1977]).The second term in equa-tion (3)represents the value of the capitalized debt tax shield after consid-ering personal tax rates on equity and debt income.Note that if τpb =τps ,then we obtain V L =V U +τc B L ,as in Modigliani and Miller [1963].Miller [1977]argues that if the tax rate on equity income is zero (i.e.,τps =0),then (1−τpb )=(1−τc )in equilibrium and the tax benefit from debt completely disappears.However,DeAngelo and Masulis [1980]argue that τpb <τc +τps (1−τc )in equilibrium.Thus,there is still a net gain from leverage,although less than the amount predicted by Modigliani and Miller [1963].By definition,V L =S L +B L and V U =S U ,where S L (S U )is the market value of equity for the levered (unlevered)firm.Substituting the expressions V L and V U into equation (3),we obtain S L +B L =S U + 1−(1−τc )(1−τps )1−τpbB L ,(4)which is equivalent toS U =S L +(1−τc )(1−τps )1−τpb B L .(5)We are interested in determining how the relation between the cost of eq-uity and leverage is affected by corporate and personal taxes.The value of levered and unlevered equity can be expressed as a perpetual stream of after-corporate tax earnings capitalized at the appropriate rate to obtainS U =X (1−τc )K U and (6)S L =(X −rB L )(1−τc )K L,(6 )where K U is the cost of unlevered equity and K L is the cost of levered equity.We set equations (6)and (6 )equal to X (1−τc )and combine to obtain696D .DHALIWAL ,S .HEITZMAN ,AND O .Z .LIK L =S U S L K U −r (1−τc )B L S L .(7)After substituting equation (5)into equation (7),we obtain K L =K U +(1−τc ) K U 1−τps 1−τpb −r B L S L ,(8)where B L /S L is the debt-to-equity ratio of the firm.Equation (8)indicates that the cost of equity is a function of leverage and corporate and investor level taxes.In the absence of taxes,equation (8)simplifies toK L =K U +(K U −r )B L S L,(9)which is equivalent to the expression derived by Modigliani and Miller [1958,p.272]for the cost of equity in the absence of taxes.That is,the expected yield of a share of stock is equal to the appropriate capitalization rate K U for a pure equity stream in the firm’s risk class,plus a premium related to financial risk that is equal to the product of the debt-to-equity ratio and the spread between the cost of capital for the all-equity firm and the cost of debt.If corporate taxes are introduced,equation (8)becomes K L =K U +(1−τc )(K U −r )B L S L,(10)which is equivalent to the expression in Modigliani and Miller [1963,p.439].Note that due to corporate level taxes the equity risk premium from leverage in equation (10),K U −r ,is smaller by a factor of one minus the corporate tax rate.That is,the tax benefit from debt offsets the leverage-related risk premium demanded by equity holders.When investor level taxes are introduced,the value of the tax benefit from debt depends on the marginal investors’relative tax rates on interest and equity income.If the tax rate on interest income is greater than that on equity income,the value of the tax benefit from debt will be reduced,increasing the equity risk premium associated with leverage.The following discussion utilizes equation (8)to derive our empirical predictions related to the effect of leverage and corporate and personal taxes on the cost of equity capital.We are interested in understanding how taxes affect the leverage-related risk premium demanded by equity holders.We first take the derivative of K L with respect to B L /S L in equation (8)to obtain ∂K L ∂(B L /S L )=(1−τc ) K U 1−τps 1−τpb −r .(11)This represents the theoretical equity risk premium from leverage in our model.Equation (11)is positive as long as K U (1−τps )>r (1−τpb ).That is,the effect of leverage on the cost of equity is positive as long as the after-tax return on equity is greater than the after-tax return on debt.This appearsTAXES AND LEVERAGE697 reasonable over a relevant range of leverage,as suggested in Modigliani and Miller[1958].Consistent with prior literature,thefirst hypothesis is: H1:Thefirm’s cost of equity is increasing in leverage.To examine the effect of corporate taxes on the equity risk premium from leverage,we take the derivative of K L with respect to B L/S L andτc in equation(8)to obtain∂2K LL L)∂τc =−K U1−τps1−τpb+r.(12)Equation(12)is negative as long as K U(1−τp s)>r(1−τpb).That is, the effect of corporate taxes on the equity risk premium from leverage is negative as long as the after-tax return on equity is greater than the after-tax return on debt.This implies that the effect of leverage on cost of equity is decreasing in the corporate tax benefit provided by the interest expense deduction.Thus,our second hypothesis is:H2:The effect of leverage on thefirm’s cost of equity is decreasing in thefirm’s tax benefit from debt.To investigate how personal level taxes affect the equity risk premium from leverage,we use(1−τps)/(1−τpb)to proxy for the personal tax disadvantage of debt.Within the DeAngelo and Masulis[1980]framework, this ratio captures the relative pretax rates of return demanded by debt and equity investors.This term is increasing in the personal tax disadvantage of interest income and is multiplied by(1−τc)in equation(3)to determine the net gain to leverage.We take the derivative of K L in equation(8)with respect to B L/S L and(1−τps)/(1−τpb)to obtain∂2K L∂(B L/S L)∂[(1−τps)/(1−τpb)]=K U(1−τc)>0.(13) Equation(13)implies that the effect of leverage on the cost of levered equity is increasing in the personal tax disadvantage associated with debt.The intuition behind this result can be argued within the theoretical context of Miller[1977]and DeAngelo and Masulis[1980].In theory,as the tax rate on interest income increases relative to the tax rate on equity income, bondholders demand higher relative pretax returns to leave them equally well off on an after-tax basis.The resulting higher interest cost reduces the tax benefit from debt accruing to equity holders.As a result,the equity risk premium from leverage should be increasing in the personal tax penalty on interest income.Thus,the third hypothesis that we test is:H3:The effect of leverage on thefirm’s cost of equity is increasing in the personal tax penalty associated with debt.Empirical evidence consistent with these hypotheses provides support for the view that the tax consequences of capital structure decisions are relevant to equity holders’expected returns.698D.DHALIWAL,S.HEITZMAN,AND O.Z.LI2.2THE ROLE OF DIVIDEND POLICYMiller and Modigliani[1961]demonstrate that in the absence of taxes, dividend policy does not affectfirm value.However,they acknowledge that differential taxation of dividends and capital gains can change this conclu-sion.Brennan[1970]shows that if the tax rate on dividends is higher than that on capital gains,the cost of equity capital should increase in dividend yield.4Recent empirical evidence is consistent with this prediction(e.g., Ayers,Cloyd,and Robinson[2002],Dhaliwal,Li,and Trezevant[2003], Dhaliwal et al.[2005]).In a related paper,Dhaliwal et al.[2005,p.5]follow Poterba and Summers [1985]and model the before-tax expected return on equity,R BT,asR BT=R TF1−τcg+τd−τcg1−τcgy,(14)where R TF is the return on a tax-free security of equivalent risk and y is the expected dividend payment divided by equity value.The focus of Dhaliwal et al.[2005]is whether dividend taxation affects expected returns,whereas our focus is whether the tax consequences of capital structure affect the cost of equity.However,the expressions for the expected return on equity in Dhaliwal et al.[2005]and in this paper must be identical for a given amount of risk and leverage.To show the relation between the two models,wefirst assume that equa-tion(14)holds within a risk class,where leverage is constant within that class.If leverage is set equal to zero,then it must be thatR(B/S)=0 BT =R(B/S)=0TF1−τcg+τd−τcg1−τcgy=K UZ+τd−τcg1−τcgy=K U.(15)We interpret K UZ as the cost of capital for an all-equityfirm that pays no dividends.After substituting equation(15)for K U in equation(8),we obtainK L=K UZ+τd−τcg1−τcgy+(1−τc)K U Z+τd−τcg1−τcgy1−τps1−τpb−rB LS L.(16)This expression implies that the dividend policy of thefirm has two po-tential effects:first,it increases the cost of equity when dividends are tax disadvantaged independent of leverage,and second,it affects the equity risk premium from leverage via bothτps,the weighted-average tax rate on4The presence of dividend tax clienteles can mitigate this dividend tax effect(Litzenberger and Ramaswamy[1979,1980,1982]).TAXES AND LEVERAGE699 equity income,and K U,the cost of capital for the all-equityfirm.5In other words,the tax treatment of dividends at the investor level is presumed to affect expected returns independent of leverage,but is also correlated with the personal tax penalty associated with debt.Therefore,we incorporate the effect of dividend taxation into the empirical model.3.Empirical MethodologyIn this section,we empirically examine the effect of corporate and in-vestor level taxes on the association between afirm’s leverage and its cost of equity capital.To operationalize tests of the theoretical predictions derived in equations(11)to(13),we require estimates of thefirm’s cost of equity, leverage,and corporate tax rate,and the marginal investors’tax rates on equity and debt income.We begin this section with a description of our estimate of the cost of equity,and continue with a discussion of the various corporate and personal level tax rates used in this study.3.1IMPLIED COST OF EQUITY CAPITALWe use the discount rate implied from variations on the residual income valuation model to estimate thefirm’s cost of equity,K L.This estimation approach utilizes theoretical relationships between observed market values and forecasted earnings,dividends,and book values of equity to infer the pretax return required by the price-setting shareholder.At a theoretical level,ex ante estimation is more appropriate for estimating the return de-manded by shareholders than methods that rely on ex post realizations. Several recent studies have used one or more implied cost of equity measures to examine various questions in accounting andfinance(e.g., Botosan and Plumlee[2002],Francis et al.[2004],Hail and Leuz[2006]). We estimate the cost of equity for our samplefirms using the methodologies described in Gebhardt,Lee,and Swaminathan[2001],Claus and Thomas [2001],Gode and Mohanram[2003],and Easton[2004].We refer to these estimates as r gls,r ct,r ojn,,and r mpeg,respectively.All four of these measures have been used in the literature to estimate thefirm’s cost of equity;how-ever,there is considerable variation in the magnitude of the associations between the various implied cost of equity estimates and individual risk proxies,and there does not appear to be a consensus as to the superiority of any particular model in estimating the cost of equity.For example,Botosan and Plumlee[2005]find that r gls is not consistently related to risk proxies, while Guay,Kothari,and Shu[2005]find that r gls is the best predictor of future realized returns.Limiting empirical analysis to just one measure may produce spurious results if particular attributes of the model are correlated5It can be shown that when dividends are zero(i.e.,y=0)or when the tax rates on dividends and capital gains are equal,the equity risk premium from leverage is not a function of the dividend tax rate.700D.DHALIWAL,S.HEITZMAN,AND O.Z.LIwith the variable of interest.To mitigate the effect that particular assump-tions of each model might have on our results,we follow Hail and Leuz [2006]and use the average of the four implied cost of equity estimates in our empirical tests.We also present results for the individual cost of equity estimates to show how the associations among leverage,taxes,and the cost of equity vary across the models.The appendix describes in detail the four models used to estimate the firm’s cost of equity,the input variable definitions,and particular definitions or assumptions unique to each model.We follow Gebhardt,Lee,and Swami-nathan[2001]and Gode and Mohanram[2003]and calculate the cost of equity at the end of June for each year t.For all measures,we require that thefirm have one-and two-year-ahead earnings-per-share forecasts(FEPS t+1 and FEPS t+2)and either a three-year-ahead earnings forecast(FEPS t+3)or long-term growth forecast(LTG).The Gode and Mohanram[2003]appli-cation requires that FEPS t+1≥0and FEPS t+2≥0,while Easton[2004]adds the condition that FEPS t+2≥FEPS t+1>0.We require samplefirms to have all four measures in order to calculate the average equity risk premium,r avg. When using r gls,r ct,r ojn,,or r mpeg as the dependent variable,we utilize all available observations.Cost of equity estimates are obtained by searching over the range of0% to100%for the value that minimizes the difference between the discounted future earnings and the current market price.The exception is r ojn,which can be estimated explicitly.The primary cost of equity proxy used in our em-pirical tests,r avg,is the average of the four implied cost of equity estimates. To obtain the equity risk premiums used in the empirical tests,we subtract the yield on a10-year Treasury note.Annual risk premium estimates derived from the four models,and the sample average across the four measures,are reported in panel A of table1.The magnitudes of the premiums are gen-erally consistent with those obtained in prior studies.The mean(median) risk premium over the sample period is4.95%(4.30%).Consistent with prior research,r mpeg and r ojn produce the largest equity risk premium esti-mates,whereas r gls produces the smallest(e.g.,Botosan and Plumlee[2005], Guay,Kothari,and Shu[2005]).Spearman correlation coefficients between the individual risk premiums and the average measure are shown in panel B and reveal the expected positive correlations between these measures, with the highest correlation between r mpeg and r ojn.The correlation coeffici-ents between r avg and the individual measures range from0.676to0.916.3.2CORPORATE AND PERSONAL TAX RATESEquation(11)predicts that the effect of leverage on the cost of equity is a function of thefirm’s tax rate,τc.If thefirm expects to have positive taxable income in current and future years,τc is generally equal to the top marginal corporate tax rate.If thefirm cannot fully utilize its interest deductions in the period paid,τc should depend on the tax attributes of thefirm,including the effect of net operating loss(NOL)carryforwards, investment tax credits(ITC),and the alternative minimum tax(AMT).TAXES AND LEVERAGE701T A B L E1Descriptive Data and Correlation Coefficients for Implied Cost of Equity PremiumsThis table presents annual sample means of equity risk premium estimates.r gls,r ct,r ojn,and r mpeg are the implied cost of equity estimates derived from the models described in the appendix less the rate on a10-year Treasury note.r avg is the average of r gls,r ct,r ojn,and r mpeg forfirms with cost of capital estimates available from all four models.Correlation coefficients are average annual Spearman correlations.All correlation coefficients are significant at the0.001level.Panel A:Annual average of cost of equity premiumsYear N(r avg)r avg r gls r ct r ojn r mpeg 1982719 5.09 1.97 5.53 6.81 6.37 1983820 4.22 1.82 3.59 6.60 5.89 1984913 3.850.95 4.69 5.67 4.65 1985883 4.43 2.33 4.56 5.97 5.30 1986865 4.59 3.09 5.11 6.03 5.88 1987866 4.13 2.24 4.28 5.66 5.56 1988807 4.08 2.89 4.74 5.20 6.76 1989803 4.19 3.21 5.04 5.19 4.63 1990829 4.48 2.62 4.66 5.66 5.52 1991848 4.58 2.95 4.71 6.03 6.11 1992885 5.40 3.51 4.94 6.807.22 1993907 5.67 4.37 5.38 6.837.26 1994973 4.80 3.60 5.05 5.96 5.90 19951,030 5.47 4.13 5.61 6.51 6.60 1996997 4.38 3.12 4.57 5.51 5.41 19971,187 4.80 3.88 5.38 5.77 5.77 19981,273 5.62 5.27 6.64 6.65 6.79 19991,135 5.50 5.21 6.69 6.37 6.56 2000994 5.99 5.607.45 6.71 6.89 2001753 5.46 6.127.06 6.23 6.69 2002731 5.63 6.32 6.74 6.607.39 2003514 5.687.52 6.357.088.05 2004588 5.02 6.10 4.73 5.66 6.04N20,32022,87322,76920,53720,377Mean 4.95 3.87 5.43 6.14 6.11Median 4.30 2.71 3.69 5.49 4.98 Panel B:Spearman correlation coefficients between cost of equity estimatesr gls r ct r ojn r mpeg r avg r gls 1.0000.4640.4510.4700.689 r ct 1.0000.4930.4150.676 r ojn 1.0000.9420.916 r mpeg 1.0000.899 r avg 1.000 An important issue is how to measure the tax benefit from debt capturedbyτc in equation(8).In theory,the level of debt should be increasing in the marginal tax rate of thefirm.Most proxies for thefirm’s marginal tax rate are based on earnings after interest costs are deducted.6However,firms that6See Graham[1996b],Plesko[2003],and Shevlin[1990]for discussions and analyses of various marginal tax rate proxies.。

1. Introduction, Course Overview and the Examples for PresentationBall R., and P. Brown. 1968. An Empirical Evaluation of Accounting Income Numbers. Journal of Accounting Research 6: 159-178.Beaver W.H., 1968. The Information Content of Annual Earnings Announcements. Journal of Accounting Research 6: 67-92.2. The Information Content of Accounting Earnings: ERCEaston, P., and M. Zmijewski. 1989. Cross-Sectional Variation in the Stock Market Response to Accounting Earnings Announcements. Journal of Accounting and Economics 11: 117-141.Collins, D.W., and S.P. Kothari. 1989. An Analysis of Intertemporal Cross-Sectional Determinants of Earnings Response Coefficients. Journal of Accounting and Economics 11: 143-181.Lipe, C., 1986. The Information Contained in the Components of Earnings. Journal of Accounting Research 24: 37-64.3. Other Accounting Information and Stock PricesBowen, R.M., D. Burgstahler, and L. A. Daley. 1986. Evidence on the Relationships between Earnings and Various Measures of Cash Flow. The Accounting Review 61: 713-725.Jegadeesh N., and J. Livnat. 2006. Revenue Surprises and Stock Returns. Journal of Accounting and Economics 41: 147-171.Kothari S.P., and R. G. Sloan. 1992. Information in Price about Future Earnings: Implications for Earnings Response Coefficients. Journal of Accounting and Economics 15: 143-171.4. Time-Series Properties of Accounting InformationFoster, G., 1977. Quarterly Accounting Data: Time-Series Properties and Predictive-Ability Results. The Accounting Review 52: 1-21.Brooks, L., and D. Buckmaster. 1976. Further Evidence of the Time Series Properties of Accounting Income. The Journal of Finance 31: 1359-1373.Freeman, R., J. Ohlson, and S. Penman. 1982. Book Rate-of-Return and Prediction of Earnings Changes: An Empirical Investigation. Journal of Accounting Research 20: 639-653.5. Analyst ForecastsO’ Brien, P., 1988. Analysts’ Forecasts as Earnings Expectations. Journal of Accounting and Economics 10: 538-.Dechow, P., A. Hutton, and R. Sloan. 2000. The Relation between Analysts’Long-TermEarnings Forecasts and Stock Price Performance Following Equity Offering. Contemporary Accounting Research 17: 1-32.Irvine, P.J. 2004. Analysts’ Forecasts and Brokerage-Firm Trading. The Accounting Review 79: 125-149.6. Earning Management: Part IBurgstahler, D., and I.D.Dichev. 1997. Earnings Management to Avoid Earnings Decreases and Losses. Journal of Accounting and Economics 24: 99-126.Matsumoto, D. 2002. Management’s Incentives to Avoid Negative Earning Surprises. The Accounting Review 77: 483-514.Jones, J. 1991. Earnings Management during Import Relief Investigations. Journal of Accounting Research 29: 193-228.7. Earning Management: Part IIDeFond, M.L., and J. Jiambalvo. 1994. Debt Covenant Violation and Manipulation of Accruals. Journal of Accounting and Economics 17: 145-176.Gramlich, J.D., M.L. McAnally, and J. Thomas. 2001. Balance Sheet Management: The Case of Short-Term Obligations Reclassified ad Long-Term Debt. Journal of Accounting Research 39: 283-295.Daniel, N.D., D.J. Denis, and L. Naveen. 2008. Do Firms Manage Earnings to Meet Dividend Thresholds? Journal of Accounting and Economics 45: 2-26.8. Management Disclosures and Disclosure QualityBotosan, C., 1997. Disclosure Level and the Cost of Equity Capital. The Accounting Review 72: 323-349.Skinner, D. 1994. Why Do Firms V oluntarily Disclose Bad News? Journal of Accounting Research 32: 38-60.Lang M.H., and R.J. Lundholm. 1996. Corporate Disclosure Policy and Analyst Behavior. The Accounting Review 71: 467-492.9. Financial Accounting: an International View（3学时）Ball, R., S.P. Kothari, and A. Robin. 2000. The Effect of International Institutional Factors on Properties of Accounting Earnings. Journal of Accounting and Economics 29: 1-51.Morck, R., B. Yeung, and W. Yu. 2000. The information Content of Stock Markets: Why DoEmerging Markets Have Synchronous Stock Price Movements? Journal of Financial Economics 58: 215-260.Lang, M., J.S. Ready, and M.H. Yetman. 2003. How Representative Are Firms that Are Cross-Listed in the United States? An Analysis of Accounting Quality. Journal of Accounting Research 41: 363-386.参考书目[加]威廉姆·司可脱著，陈汉文译，《财务会计理论》，机械工业出版社。

高盛财经词典—英汉对照A1. accounting (会计)The process of recording, summarizing, and analyzing financial transactions in order to prepare financial statements and reports.会计是记录、汇总和分析财务交易的过程，以便编制财务报表和报告。

2. asset (资产)Anything that has a value and is owned by an individual, company, or organization.任何具有价值并由个人、公司或组织拥有的物品。

3. audit (审计)An independent examination and verification of an organization’s financial records and sta tements by a qualified person or firm.由合格的个人或公司对组织的财务记录和报表进行独立检查和核实。

B1. balance sheet (资产负债表)A financial statement that shows a company’s assets, liabilities, and shareholders’ equity at a specific point in time.资产负债表是一份显示公司在特定时间点的资产、负债和股东权益的财务报表。

2. bear market (熊市)A market condition in which prices of securities are falling or expected to fall, often characterized by widespread pessimism and selling.指证券价格下跌或预计下跌的市场状况，通常以广泛的悲观情绪和抛售行为为特征。

Journal of Accounting ResearchVol.40No.1March2002Printed in U.S.A.A Re-examination of DisclosureLevel and the Expected Costof Equity CapitalC H R I S T I N E A.B O T O S A N∗A ND M A R LE N E A.P L U M L E E∗Received10January2000;accepted8October2001ABSTRACTThis paper examines the association between the cost of equity capital and levels of annual report and timely disclosure,and investor relations activities.We estimate the cost of equity capital using the classic dividend discount model.Wefind that the cost of equity capital decreases in the annual report disclosure level but increases in the level of timely disclosures.The latter result is contrary to theory but is consistent with managers’claims that greater timely disclosures may increase the cost of equity capital,possibly through increased stock price volatility.Wefind no association between the cost of equity capital and the level of investor relations activities.We conclude that aggregating across different disclosure types results in a loss of information.Failing to include all disclosure types in regression analyses may lead to a correlated omitted variable bias and erroneous conclusions.I.IntroductionThis paper explores the association between the expected cost of equity capital and three types of disclosure(annual report,quarterly and other∗University of Utah.The authors would like to thank Professor Shelley Rhoades for her assistance in using Mathematica and Professor Nicolas Bollen for his assistance with the numer-ical approximation program.We would also like to thank our anonymous reviewer,Andrew Christie,Myron Gordon,Neil Bhattacharya,Uri Loewenstein,Jim Ohlson,Taylor Randall and the workshop participants at the2000American Accounting Association Annual Meeting, Louisiana State University,The Eleventh Annual Conference of Financial Economics and Ac-counting at the University of Michigan,New York University,University of Notre Dame,and the University of Utah for their helpful comments and suggestions.21Copyright C ,University of Chicago on behalf of the Institute of Professional Accounting,200222C.A.BOTOSAN AND M.A.PLUMLEEpublished reports,and investor relations)examined by the Association for Investment Management and Research in their Corporate Information Committee’s Annual Reviews of Corporate Reporting Practices(AIMR reports). As expected,wefind that the cost of equity capital is decreasing in annual report disclosure level.The magnitude of the difference in the cost of eq-uity capital between thefirms providing the most annual report disclosure relative to those providing the least is approximately0.7percentage points, after controlling for market beta andfirm size.In contrast to our expec-tations,however,wefind a positive association between the cost of equity capital and the level of more timely disclosures,such as the quarterly report to shareholders.We show that the cost of equity capital is approximately 1.3percentage points higher forfirms providing the most quarterly and other published report disclosure relative tofirms providing the least of this type of disclosure,after controlling for market beta andfirm size.This re-sult,while contrary to that predicted by theory,is consistent with managers’claims that greater timely disclosure increases the cost of equity capital, possibly through increased stock price volatility.Finally,wefind no associ-ation between the cost of equity capital and the level of investor relations activities.Using annual report disclosures for one industry,within a single year, Botosan[1997]documents a negative association between the cost of eq-uity capital and voluntary disclosure level forfirms with a low analyst follow-ing butfinds no association between these variables forfirms with a high analyst following.Our results,based on a much larger sample,suggest that firms with a high analyst following benefit from providing greater annual re-port disclosure.Moreover,this paper addresses two important questions left unanswered by Botosan[1997].Does type of disclosure matter?Our results suggest that type of disclosure is critical since we document negative,posi-tive,and no association between disclosure level and the cost of equity cap-ital depending on disclosure type.Do the results generalize to a sample not limited to one year[1990]or one industry(machinery)?Our analysis con-firms and extends the results documented in Botosan[1997]for low analyst followingfirms to a sample comprised of large,heavily followedfirms rep-resenting43different industries and spanning an eleven-year period from 1986–1996.II.Hypothesis DevelopmentA number of recent empirical studies suggest a link between the cost of equity capital and disclosure.For example,Frankel,McNichols,and Wilson [1995]find that managers offirms that access the capital markets provide more frequent management earnings forecasts.Welker[1995]documents a negative association between disclosure levels and relative bid-ask spreads. As discussed previously,Botosan[1997]documents a negative association between the cost of equity capital and disclosure level forfirms with a low analyst following.Healy,Hutton,and Palepu[1999]find thatfirms thatDISCLOSURE LEVEL AND EXPECTED COST OF EQUITY CAPITAL23 increase their disclosure level experience increases in stock performance, institutional ownership,analyst following,and stock liquidity.Finally,Lang and Lundholm[2000]conclude thatfirms that increase their disclosure level in anticipation of a stock offering experience price increases prior to the offering.Each of the studies described in the preceding paragraph relies on two streams of theoretical research to support the hypothesis that greater dis-closure is associated with a lower cost of equity capital.Thefirst stream suggests that greater disclosure enhances stock market liquidity,thereby re-ducing the cost of equity capital either through reduced transaction costs or increased demand for afirm’s securities.1For example,Amihud and Mendelson[1986]suggest that the cost of equity capital is greater for secu-rities with wider bid-ask spreads because investors require a higher return to compensate for added transaction costs.Disclosing information allowsfirms to reduce the adverse selection component of the bid-ask spread,thereby reducing their cost of equity capital.Diamond and Verrecchia[1991]claim that greater disclosure reduces the amount of information revealed by a large trade.When the adverse price impact of such a trade is reduced,in-vestors are willing to take larger positions in afirm’s securities,thereby increasing the demand for its securities and reducing its cost of equity capital.The second stream of research suggests that greater disclosure reduces the estimation risk associated with investors’assessments of the parameters of an asset’s return or payoff distribution.2These researchers maintain that investors estimate the parameters of a security’s payoff distribution based on available information about thefiing a Bayesian approach and realizing that investors form predictive distributions as a function of their uncertainty about the true parameters,Barry and Brown[1985],Handa and Linn[1993],and Coles,Loewenstein,and Suay[1995]conclude that estimation risk(or information risk)is nondiversifiable.They also suggest that the traditional CAPM formula for market beta does not reflect this risk,resulting in estimates of market beta that are too low for low infor-mation securities.To date,there is no consensus in the literature regard-ing the diversifiability or lack thereof,of estimation risk(Clarkson,et.al [1996]).The theoretical and empirical research,discussed above,support the fol-lowing hypothesis:H a:There is a negative association between the cost of equity capitaland disclosure level.1See for example,Demsetz[1968],Copeland and Galai[1983],Glosten and Milgrom [1985],Amihud and Mendelson[1986]and Diamond and Verrecchia[1991].2See for example,Klein and Bawa[1976],Barry and Brown[1985],Coles and Loewenstein [1988],Handa and Linn[1993],Coles,et al.[1995],and Clarkson,et.al.[1996].24C.A.BOTOSAN AND M.A.PLUMLEEIII.Sample SelectionOur sample selection begins with the4,705firm-year observations in-cluded in the AIMR Reports dated from1985/86through1995/96.3We require Value Line forecasts to calculate our measure of the expected cost of equity capital,so our sample is limited tofirms followed by Value Line. This reduces our sample by23%to3,623firm-year observations.Even when Value Line follows afirm,the data necessary to form our cost of equity capital measure are not always available.Eliminating these observations from the sample yields afinal sample of a maximum of3,618firm-year observations. Table1summarizes our sample selection procedures and shows the dis-tribution of the3,618firm-year observations across industries(panel B)and years(panel C).The number of times a givenfirm appears in the sample is provided in panel D.As shown in panel B,the sample is well dispersed across industries.No one industry contributes greater than10%of the ob-servations to the sample except for banking,which accounts for11.25%of the total.The sample is fairly evenly distributed across years as well,with 1991contributing the largest proportion of observations of any single year (12.05%).Our sample includes668individualfirms.Of these,110firms (16.47%of the number offirms)appear in our sample in only one year. However,72firms(10.78%of the number offirms)appear in the sample in all eleven years and contribute21.89%of thefirm-year observations.Since the samefirm can appear multiple times in our data we perform sensitivity analyses to ensure that our conclusions are not sensitive to the inclusion of multiple observations perfirm.IV.The Model and Empirical ProxiesTHE MODELWe test our hypothesis by regressing the expected cost of equity capital (r)on market beta(BETA),the natural log of market value(LMVAL),and fractional disclosure rank(RDSCR).That is,r it=γ0+γ1BETA it+γ2LMVAL it+γ3RDSCR it+εit.(1) Using alternative specifications of regression equation(1),we examine the impact on the cost of equity capital of cross-sectional variation in total disclosure level and cross-sectional variation in disclosure level by type of disclosure.The three types of disclosure we examine are those included in the AIMR Reports:annual report,other publications,and investor relations. Consequently,in our empirical analysis we replace RDSCR by RTSCR(the 3Typically,the AIMR produces scores or ranks for each category of disclosure(annual and other required reports,quarterly reports and other published information and investor relations)and a total score or rank for eachfirm within an industry.In some instances,however, only total scores or ranks are reported.This reduces our overall sample size when category scores or ranks are used as independent variables.DISCLOSURE LEVEL AND EXPECTED COST OF EQUITY CAPITAL25T A B L E1Sample Selection ProceduresThe table below shows the determination of the sample and the distribution offirm-year observations by industry membership,year and frequency.Industry names and the allocation offirm-year observations across industries are taken from the Annual Reviews of Corporate Reporting Practices prepared by the Corporate Information Committee of the Association for Investment Management and Research.Panel A:Sample selection process#% Totalfirm-years followed by AIMR4705100.0 Totalfirm-years not followed by Value Line108223.0 Totalfirm-years with insufficient data50.1 Totalfirm-year observations361876.9Observations by industryYears inPanel B:Sample breakdown by industry Sample#% Aerospace86–9166 1.82 Airline86–9690 2.49 Apparel86–9482 2.27 Automotive96110.30 Banking86–9340711.25 Canadian Banking94–9610.03 Chemical87–95104 2.87 Coal Mining91–9260.17 Computer and Electrical89–9253 1.46 Construction89–9652 1.44 Container and Packaging89–9342 1.16 Diversified Companies88–9349 1.35 Domestic Oil86–9698 2.71 Domestic Oil Refining91–96240.66 Drilling and Oil8680.22 Electrical Equipment86–96100 2.76 Environmental Control86–9654 1.49 Financial Services Industries86–9498 2.71 Food,Beverage and Tobacco86–96209 5.78 Health Care86–96180 4.98 Health Care Services87–8870.19 Independent Oil88–92280.77 Insurance Sub86–962727.52 International Oil86–9676 2.10 International Pharmaceuticals92–9430.08 Machinery86–95150 4.15 Motor Carrier86–91340.94 Natural Gas Distributors86–96104 2.87 Natural Gas Pipeline86–95105 2.90 Nonferrous&Mining90–92260.72 Oil and Gas Drilling91–9244 1.22 Oil Service and Equipment87–90140.39 Paper and Forest Products88–96154 4.26 Precious Metals91–9649 1.35 Publishing and Broadcasting86–96178 4.92 Railroad86–9669 1.91 Retail Trade86–962817.7726C.A.BOTOSAN AND M.A.PLUMLEET A B L E1—ContinuedObservations by industryYears inPanel B:Sample breakdown by industry Sample#% Savings Institutions89–93190.53 Service Oil8680.22 Software Data89–93101 2.79 Specialty Chemicals86–94122 3.37 Telecommunications9450.14 Textiles86–94350.97 Totalfirm-year observations3618100.00Observations by year Panel C:Sample breakdown by year#% 19862938.10 19872968.18 19882958.15 198938110.53 199042611.78 199143612.05 199241911.58 199337710.42 19942587.13 1995228 6.30 1996209 5.78 Totalfirm-year observations3618100.00Firms Observations Panel D:#of times a givenfirm appears#%#% 111016.47110 3.04 2639.43126 3.48 3659.73195 5.39 46910.332767.63 5527.782607.18 6537.933188.79 742 6.292948.13 86910.3355215.26 935 5.243158.71 1038 5.6938010.50 117210.7879221.89 Totalfirms andfirm-year observations668100.003618100.00fractional rank of the AIMR’s total disclosure score)in one specification of the model.In the alternative specification RDSCR is replaced by three disclosure measures:RANLSCR(the fractional rank of the annual report score),ROPBSCR(the fractional rank of the other publication score),and RINVSCR(the fractional rank of the investor relations score).44For completeness we also examine three specifications of equation(1)in which RDSCR is replacedfirst by RANLSCR,then by ROBPSCR andfinally by RINVSCR.DISCLOSURE LEVEL AND EXPECTED COST OF EQUITY CAPITAL27 The disclosure ranks(RTSCR,RANLSCR,ROPBSCR,and RINVSCR)are computed based on a within industry/year ranking of the sample data.These measures are discussed in more detail in the next section of the paper,as is r, our estimate of thefirm’s expected cost of equity capital.BETA is included in the models to control for systematic risk.We esti-mate BETA by the market model using a minimum of thirty monthly return observations over thefive-year period ended June30of the AIMR Report publication year with a value-weighted NYSE/AMEX market index return.5 We take data used in the computation of BETA from the1998version of the CRSP tape.Occasionally,sufficient data to compute BETA are not available on CRSP.In these instances we substitute Value Line’s estimate of market beta.LMVAL is included in the analyses because prior research documents a significant association between market value and both the expected cost of equity capital and disclosure level.This suggests market value might induce a correlated omitted variable bias if excluded from the analysis.We use the natural log of the market value of outstanding common equity as at December31of the year preceding the AIMR Report publication year in our tests.We obtain market value of common equity from the CRSP tape.In those instances where market value of common equity is missing on CRSP, we collect it from the1998version of the COMPUSTAT tape.We limit our control variables to BETA and LMVAL.In comparison, Gebhardt,Lee,and Swaminathan(GLS)[2001]include eightfirm charac-teristics in their regression of the expected cost of equity capital on various firm and industry characteristics.While this is appropriate for the research question addressed in GLS,our purpose,which is ultimately to examine the association between the expected cost of equity capital and disclosure level, is clearly different.6DESCRIPTIVE STATISTICS PERTAINING TO MARKET BETA AND FIRM SIZE Panel A of table2provides descriptive statistics forfirm size and market beta for the sample pooled across years.The data show that the mean(and median)firm included in the sample is very large.The mean market value of common equity(MVAL)is$4.97billion;the median is$1.98billion. This is in sharp contrast to the mean and medianfirm size of the sample employed in Botosan[1997],$713million and$209million,respectively. Clearly,limiting the analysis tofirms included in the AIMR Reports produces 5AIMR Reports tend to be published in the last quarter of the year.We assume that each report assessesfirms’disclosure practices during a one-year period ending June30of the publication year.For example,the1993/94report was published in November of1994.We assume this report evaluates disclosures made byfirms during the period July1,1993through June30,1994.6The purpose of the GLS study is to describe the cross-sectional relation between expected cost of equity capital and a survey offirm and industry characteristics found in prior research to be statistically associated with realized returns.None of the variables examined in GLS is a measure of disclosure level.28C.A.BOTOSAN AND M.A.PLUMLEET A B L E2Descriptive Statistics During the Period1986–1996for Both Pooled Sample and Year-by-Year The table below provides descriptive statistics for the sample pooled across the sample pe-riod1986–1996and on an annual basis.Our data set includes3,618total disclosure ranks but only3,463total disclosure scores since only rank data are provided for some industries. The number of observations with category disclosure scores is less than3,463because some industry subcommittees do not breakdown the total disclosure score by disclosure category. The number of disclosure scores for the investor relation category slightly exceeds the num-ber of disclosure scores for the annual report and other publications categories because the Oil Service and Drilling Industry Subcommittee did not disclose annual report and other publication scores in1987.MVAL is the market value of common equity on December31st of the year prior to the publication year of the AIMR Report.BETA is estimated via the mar-ket model using a minimum of30monthly returns over the60months prior to June of the publication year of the AIMR Report.We estimate the market model with a value weighted NYSE/AMEX market index return.DANLSCR(DOPBSCR,DINVSCR,DTSCR)is the indus-try/year mean-differenced annual report(other publications,investor relation,total)score. The mean-differenced disclosure scores are computed by subtracting the industry/year av-erage score for a given disclosure category from thefirm’s score.We convert this into a percentagefigure by dividing the difference by the proportion of total points allocated to the given category and multiplying the result by one hundred.The resultingfigure is the number of percentage points by which a givenfirm’s score deviates from the industry mean score for a given year.r DIV is the estimated cost of equity capital derived from the dividend discount formula.Panel A:Pooled sampleVariable MVAL BETA DANLSCR DOPBSCR DINVSCR DTSCR r DIV n3618361824192419243334633618 Mean4967.7 1.1060.0000.0000.0000.0000.165 Percentiles:1%83.20.237−23.706−30.227−35.686−30.1260.024 25%795.50.888−5.127−6.480−6.833−5.4480.120 50%1976.0 1.1010.4640.833 1.418 1.0390.156 75%4747.4 1.314 5.5207.3338.565 6.3640.202 99%54484.0 2.13119.95023.79324.88220.3650.393 Std.Dev.9690.20.3738.72311.30612.6709.9470.073 Panel B:Year-by-year resultsYear MVAL BETA DANLSCR DOPBSCR DINVSCR DTSCR r DIV 19862667.4 1.06800000.144 1168.9 1.061 1.1320.902 1.6190.9830.141293293190190190285293 19873069.2 1.08700000.128 1449.4 1.0860.185 1.667 1.685 1.0780.129296296199199214296296 19883286.6 1.08800000.190 1695.4 1.059−0.0290.833 1.2880.2170.188295295213213213295295 19893296.8 1.12000000.160 1514.6 1.1180.476 1.235 1.360 1.2000.154381381252252251365381 19904267.1 1.12200000.220 1947.4 1.1070.569 1.065 1.0050.8500.208426426298298298405426DISCLOSURE LEVEL AND EXPECTED COST OF EQUITY CAPITAL29T A B L E2—ContinuedPanel B:Year-by-year resultsYear MVAL BETA DANLSCR DOPBSCR DINVSCR DTSCR r DIV 19914037.4 1.14900000.176 1571.0 1.1360.2040.23600.8410.164436436263263263393436 19925465.1 1.12400000.176 2052.2 1.1280.3870 1.998 1.2290.166419419256256256373419 19935993.7 1.16900000.148 2758.3 1.1920.7590.938 2.187 1.3850.145377377245245245356377 19947254.6 1.08900000.162 3215.9 1.0980.1430.781 1.8490.8280.160258258193193193258258 19958048.2 1.03800000.134 3341.9 1.0590.464 1.782 2.106 1.1720.132228228164164164228228 199610637.0 1.00400000.127 3879.90.945 1.1070.6240.8260.2790.126209209146146146209209 a sample of largerfirms that tend to be more heavily followed byfinancial analysts.7Panel B provides similar information to panel A but on a year-by-year basis.The average(median)samplefirm’s market value of common eq-uity was$2.67($1.17)billion in1986.By1996this had grown to$10.64 ($3.88)billion.Mean year-by-year BETA’s are comparable to their corre-sponding medians.Mean BETA increases virtually monotonically during thefirst eight years of the sample period,peaking in1993at1.169,followed by a monotonic decline to1.004during the last three years of the period. DISCLOSURE DATAOur disclosure data are drawn from the1985/86–1995/96AIMR Reports. The stated goal of the AIMR Reports is to“improve corporate communica-tions between the investment community and the management of publicly owned corporations in the United States and elsewhere”[1995/96AIMR Report,p.1].Each year the AIMR selects a number of industries for con-sideration and forms industry subcommittees responsible for assessing the adequacy of the corporate reporting practices offirms within the industry. The subcommittees use a checklist drawn from guidelines provided by the AIMR to evaluate companies within their industries.The guidelines suggest three categories of disclosure be evaluated:(1)annual published and other 7Lang and Lundholm[1996]show that the number of analysts following the average AIMR firm during1985through1989is17.6.In contrast,the number of analysts following the average firm in Botosan’s low analyst following sub-sample is4.8analysts.30C.A.BOTOSAN AND M.A.PLUMLEErequired information,(2)quarterly and other published information not required,and(3)other aspects.The suggested weights applied to each category in arriving at the total score are40–50%,30–40%,and20–30%. It can be inferred from these suggested weights that the annual report is viewed as a particularly important document.“The annual published and other required information”category con-siders the clarity and completeness of the annual report(including the financial statements and footnotes)and required published information such as10-Ks and10-Qs.“The quarterly and other published information not required”category is concerned with the depth,clarity,and timeliness of the quarterly report to shareholders,proxy statements,annual meet-ing reports,fact books,press releases,and newsletters.Finally,access to management through presentations to analysts,company-sponsoredfield trips,and interviews is the focus of the“other aspects”category.While the guidelines provided to the subcommittees are fairly detailed and extensive,the subcommittees often deviate substantially from them and develop disclosure indices tailored to the unique characteristics of their industries.We convert the AIMR disclosure scores to within industry/year fractional disclosure ranks,defined as the rank of a givenfirm’s disclosure score divided by the number of observations having nonmissing values of the ranking variable.We rankfirms in ascending order,such thatfirms providing higher levels of disclosure receive higher ranks.As a result,if greater disclosure results in a lower cost of equity capital,the coefficient on the disclosure rank will be negative.DESCRIPTIVE STATISTICS PERTAINING TO THE DISCLOSURE DATATable2presents descriptive statistics for the disclosure data.Panel A pro-vides information pertaining to the pooled sample while panel B gives year-by-year statistics.This table presents industry mean-differenced disclosure scores as opposed to disclosure ranks because scores provide a better sense of the cross-sectional distribution of the disclosure measures.8The industry mean-differenced disclosure scores presented in this table are computed by subtracting the industry/year average score for a given disclosure category from a givenfirm’s score.We convert this into a percentagefigure by divid-ing the difference by the proportion of total points allocated to the given category and multiplying the result by one hundred.The resultingfigure is the number of percentage points by which a givenfirm’s score deviates from the industry mean score for a given year.The overall and year-by-year aver-age mean-differenced scores are all zero due to this procedure.However, the distribution of the three category mean-differenced scores(DANLSCR, 8There are fewer than3,618observations for DTSCR because only rank data are available in some industries.As a result these observations are not included in the computations based on scores,however,they are included in subsequent analysis based on ranks.In addition,the number of observations by disclosure category is always less than the number of observations in the total disclosure category because some industry subcommittees do not generate category scores.DISCLOSURE LEVEL AND EXPECTED COST OF EQUITY CAPITAL31 DOPBSCR and DINVSCR)and the total mean-differenced score(DTSCR) indicate variation in disclosure levels.For example,at the75th percentile the total disclosure score is6.364percentage points greater than the indus-try average for the given year.At the25th percentile the total disclosure score is5.448points lower than the corresponding industry/year average. Depending on the disclosure measure,the inter-quartile range is between 11and15percentage points.THE COST OF EQUITY CAPITALWe estimate the cost of equity capital(denoted below as r DIV)for each firm-year using the short horizon form of the classic dividend discount model given in equation(2),below.9P t=4τ=1(1+r)−τE t[d t+τ]+(1+r)−4P4(2)Where:P t=price at date tr=the expected cost of equity capitalE t(o)=the expectations operatord t=dividends per share for year tWe collect forecasts of dividends forfiscal years t+1and t+2and the long-range dividend forecast and maximum and minimum future price esti-mates from forecasts published by Value Line during the third quarter of the AIMR Report publication year.Since Value Line does not provide a dividend forecast for t+3,we interpolate between the t+2and long-range dividend forecasts to obtain an estimated forecast of dividends for t+3.We compute the forecast of price in year T=4(P4)by taking the mean of the minimum and maximum long-run price forecasts provided by Value Line.10We take the current stock price(P t)from CRSP on the Value Line publica-tion date or the closest date thereafter within three days of publication.We substitute Value Line’s“recent price”for price when price data is not available on the CRSP tape.In addition,we compare all CRSP price data to Value Line’s recent price data to identify potential problems arising from stock splits or stock dividends.If the difference between the CRSP price and Value Line’s recent price is greater than15%,we substitute Value Line’s recent price for the CRSP price.9Although Botosan[1997]derives her estimates from the Edwards-Bell-Ohlson(EBO) valuation model,the estimates produced by these two approaches should be identical barring any violations of the clean-surplus relation(Lundholm and O’Keefe[2001]).It is not surprising then that the Spearman rank-order correlation between the estimates is0.90(Botosan and Plumlee[2001]).Since the estimates produced by the dividend discount formula are invariant to violations of the clean-surplus relation,we employ the estimates produced by this model. However,all results hold if the cost of equity capital estimates derived from the EBO valuation model are used instead.10Alternatively the price implicit in Value Line’s long-range P/E ratio could be used.As discussed in Botosan[1997]both approaches yield virtually identical results.。