Management Decision: Article Information

Management Decision
How are corporate disclosures related to the cost of capital? The fundamental role of information
asymmetry
Beatriz Cuadrado-Ballesteros Isabel-Maria Garcia-Sanchez Jennifer Martinez Ferrero
Article information:
To cite this document:
Beatriz Cuadrado-Ballesteros Isabel-Maria Garcia-Sanchez Jennifer Martinez Ferrero , (2016),"How are corporate
disclosures related to the cost of capital? The fundamental role of information asymmetry", Management Decision, Vol. 54
Iss 7 pp. -
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How are corporate disclosures related to the cost of capital? The fundamental role
of information asymmetry
Introduction
Cost of capital, information asymmetry, and corporate disclosures are topics
studied previously in literature. Under the agency conflict, the general idea is that
information asymmetry among investors creates trading frictions by introducing adverse
selection, leading to lower levels of stock liquidity and higher expected returns (Leuz
and Verrecchia, 2000). In this context, corporate disclosures play a fundamental role in
the market, since dissemination of such information increases firms’ credibility, which
combats these market frictions and instigates the optimal functioning of an efficient
capital market (Healy and Palepu, 2001). That is, information differences among
investors lead them to lose confidence in firms, and investors will demand a higher
return for investing in firms with wide information asymmetries.
A number of studies have suggested that corporate disclosures tend to reduce
information asymmetry (e.g. Welker, 1995; Healy et al., 1999; Leuz & Verrecchia,
2000; Cormier et al., 2011; Battacharya et al., 2013); while other studies have analyzed
the impact of corporate disclosures on the cost of capital (e.g. Bloomfield & Wilks,
2000; Richardson & Welker, 2001; Hail, 2002; Petrova et al., 2012; Core et al., 2015).
From their findings, we could extrapolate a relationship between these three issues – i.e.
the cost of capital will be reduced thanks to a reduction of information asymmetries
derived from larger corporate disclosures. Nevertheless, this conclusion is extrapolated
from empirical results obtained by previous studies that analyzed separately the
relationships between the three issues (disclosures, asymmetries, and cost of capital).
1
As previously indicated, corporate disclosures could reduce information
asymmetry (Healy et al., 1999; Leuz & Verrecchia, 2000), as a component of the cost of
capital, but such relationship is more complex. The central assumption is that the
demand for corporate disclosures that reduces the information advantages of some
investors (who are more informed) arises from agency conflicts (Healy & Palepu,
2001), and these information differences in turn, determine the cost of capital. In other
words, information asymmetry could be seen as a mediator in the relationship between
corporate disclosures and the cost of capital. This issue has been previously studied by
independent models, by using different samples, methodologies, and different proxy
variables. At this regard, this paper is the first attempt to study, jointly, the effects of
decreasing information asymmetries by corporate disclosures on the cost of capital in an
international setting. In addition, we focused on both financial and social disclosures
(Bhattacharya et al., 2013), creating empirical proxies whose validity for the analysis
has been evidenced (Richardson & Welker, 2001).
Thereon, we propose a new insight into the literature, because our aim is to
analyze the relation between corporate disclosures quality and the cost of capital,
highlighting the role of information asymmetry as a mediator component. Specifically,
we empirically test three links: (i) corporate disclosure quality – information
asymmetry; (ii) information asymmetry – cost of capital; and (iii) corporate disclosure
quality – cost of capital. For this, we use a sample of 1,260 firms in the period 2007–
2014. The sample is unbalanced because not all companies appear in all periods,
resulting in 7,542 observations. The firms are from different countries—Belgium,
Canada, Denmark, Finland, France, Germany, Hong-Kong, India, Italy, Japan, the
Netherlands, Norway, Spain, Sweden, Switzerland, the UK, and the USA—and activity
2
sectors: basic materials, industrial, utilities, services industry, construction, retail,
transportation, and telecommunications.
The remainder of this paper is organized as follows: In the next section, we
develop our propositions in which our aims are operationalized; then the sample,
variables and models are shown; after that the empirical results are commented on; and
finally, we conclude with some remarks.
Theoretical background: Literature review and research propositions

Literature review
Corporate disclosures play a fundamental role in the functioning of an efficient
capital market. By increasing their disclosure, firms can combat the market frictions,
instigating the optimal functioning of an efficient capital market (Healy & Palepu,
2001). At this respect, prior evidence agrees in supporting that corporate disclosures,
both in quantity and quality, may affect the cost of financing. Specifically, information
quality is highly appreciated by investors, because if it is not readily available, well
formatted and salient, investors may not able to evaluate their investment opportunities
(Barberis & Thaler, 2003). Since quality of information affects prices, how information
is provided to the markets is highly important for the company, in terms of cost of
capital (Easley & O’Hara, 2004). Firms that consistently make quality disclosures are
perceived in the market to have a lower likelihood of withholding relevant unfavorable
information, and thus they are charged a lower risk in the market (Sengupta, 1998).
Extant literature has found, in general, a negative link between disclosure quality
and the cost of capital. For instance, Botosan (1997) reported that the negative link
between disclosure quality and the cost of capital in a sample of 122 manufacturing
firms in the 1990s’. Bloomfield and Wilks (2000) showed that better disclosure quality
3
tends to increase investors’ demand, which in turn reduces the cost of capital by
improving liquidity. For Canadian firms from 1990–1992, Richardson and Welker
(2001) documented the negative relation between quantity/quality financial and social
disclosures and the cost of equity capital. Hail (2002) and Petrova et al. (2012) showed
the same relation by using samples of Swiss companies. Francis et al. (2005a)
empirically tested the effectiveness of voluntary disclosures in obtaining financing
resources, by using a sample from 34 countries. More recently, Core et al. (2015) show
that better disclosure quality improves investors’ predictions of expected cash flows;
thus the covariance between the firms’ cash flows and the cash flows of stocks in the
market portfolio decrease, which in turn reduces the cost of capital.
Focused on financial and accounting information, Lambert et al. (2007) noted
that quality accounting information reduces the cost of capital – i.e. raising quality
accounting information moves the cost of capital closer to the risk-free rate. Barth et al.
(2005) found that firms with more earnings transparency enjoy a lower cost of capital,
and similarly Bhattacharya et al. (2003) showed that earnings opacity—i.e. the
difference between observable accounting earnings and unobservable economic
earnings—is positively associated with the cost of equity. Li (2010) evidenced that the
use of the International Financial Reporting Standards (IFRS) mandatorily reduces the
cost of equity for mandatory adopters with strong legal enforcement, by using a sample
of 1,084 EU firms from 1995–2006. And theoretically, Apergis et al. (2011) provided a
model to show that an increase in expected cash flows derived from improvements in
accounting disclosure quality, leads to a decrease in the cost of capital.
Another line of research is focused on how corporate disclosures affect
information asymmetries. Information asymmetries arise from differences in
information among investors. Informed investors have access to more information than
4
uninformed investors, who only have access to public information. For instance, Welker
(1995), Healy et al. (1999), and Leuz and Verrecchia (2000) found a negative link
between disclosure quality and the firms’ bid–ask spread as a proxy of information
asymmetry. Bhattacharya et al. (2013) show that poor earnings quality is associated
with higher information asymmetries, by using a sample of NYSE and NASDAQ firms
from 1998–2007. Meanwhile, Cormier et al. (2011) empirically found a negative link
between non-financial disclosures and information asymmetry, in terms of the bid–ask
spreads and share price volatility. Similarly, Bertomeu et al. (2011) report that voluntary
disclosures determines the information advantage of the better informed trader, while
Cui et al. (2016) justify the negative link voluntary disclosures-information asymmetry
by the decreasing of the adverse selection problem faced by less-informed investors.
From the above, the widely evidence about the negative relation between
corporate disclosures and cost of capital may respond to two perspectives. From a
“liquidity perspective”, disclosures reduce the firms’ costs of equity financing through
an improvement of future liquidity (e.g. Diamond & Verrecchia, 1991; Bloomfield &
Wilks, 2000). But there is another view, called “estimation risk perspective,” to explain
the association between disclosures and the cost of capital (Hail, 2002). “Risk
perspective” defines the cost of capital as the minimum rate of return equity investors
require for providing capital, comprised of the risk-free rate of interest and a premium
for the non-diversifiable risk (Botosan, 2006). So, reducing differences in information
decreases at least part of the estimation risk component (e.g. Handa & Linn, 1993;
Clarkson et al., 1996) which means a reduction in the final cost of equity capital. Under
this perspective, Francis et al. (2005) tested the negative link between accruals quality
and cost of equity.
5
Thereon, the argument behind these perspectives is that corporate disclosures
(quality) affect the cost of capital by decreasing information asymmetry. More
concretely, as Arthur Levitt, the former chairman of the Securities and Exchange
Commission, indicated the quality of accounting standards is positively linked to
liquidity of the market, which reduces capital costs (Levitt, 1998) – liquidity is a
function of information asymmetry (Kyle, 1985; Glosten & Milgrom, 1985). Informed
investors will hold assets where their information disadvantage is lower, i.e., when the
information asymmetry between insiders and the market is lower. Investors demand a
higher return to hold assets with greater private information (Easley & O’Hara, 2004).
Lambert et al. (2011) developed a theoretical model to explain how information
asymmetry impacts on the cost of capital. They show that illiquidity influences the
amount of information that is reflected in prices, which in turn reduces investors’
average precision, increasing the cost of capital – with imperfect competition. This
relation is empirically tested by He et al. (2013), who found that cost of capital
increases with a higher level of information asymmetry, by using a sample of firms
listed on the Australian Securities Exchange. Thereon, it is expected that firms affect
their cost of capital by corporate disclosures that essentially turn private into public
information and then differences between informed and uninformed traders decrease
(Diamond & Verrecchia, 1991).
From the above, previous studies have individually reported a relationship
between information asymmetries, corporate disclosures, and the cost of capital. A
number of studies have suggested that corporate disclosures tend to reduce information
asymmetry, as a component of the cost of capital (e.g. Welker, 1995; Healyet al. 1999;
Leuz & Verrecchia, 2000; Cormier et al., 2011; Battacharya et al., 2013). However, they
empirically report the link between disclosures and asymmetries; and they extrapolate
6
their findings in terms of cost of capital, but they fail to empirically estimate such effect.
The relationship between these three issues is more complex, and probably it could be
seen as a mediated link – i.e. information asymmetry is determined by the degree of
corporate disclosures, and it in turns affects the cost of capital. Information asymmetry
could be considered as a mediator, whose role is analyzed in this study.
Theoretical research propositions
As has already been noted, several previous studies have analyzed empirically
the relation between corporate disclosures and the cost of capital (Richardson &
Welker, 2001; Hail, 2002; Francis et al, 2005; Barth et al., 2005; Petrova et al., 2012;
Core et al., 2015). These previous studies have proposed empirical models to study the
relation between the cost of capital and corporate disclosures in the following way:
r = f (y, X) [1]
where r is a proxy of the cost of capital, y represents disclosures, and X is a
vector of different control variables, such as size, book-to-market ratio, leverage, beta,
forecast dispersion and long-term growth forecast, among others.
However, we propose a new model, taking into account explicitly the role of
information asymmetry. Our model breaks down the relation between disclosures and
the cost of capital into two steps. Firstly, disclosures affect information asymmetries,
and then information asymmetries determine the cost of capital. In sum, we introduce a
new component, z, on the functional relation [1]:
r = f (y, z, X) [2]
where z represents the level of information asymmetries. Our paper introduces
new insights into previous literature, breaking down the relation between disclosures
7
and the cost of capital into two parts: (i) how quality information affects information
asymmetries; and (ii) how information asymmetries affect the cost of capital. Thus, we
expect that information asymmetries act as a mediator between corporate disclosures
and cost of capital, such as is represented in Figure 1.
<Insert Figure 1 here>
Relation 1 represented in Figure 1 is focused on the link between corporate
disclosure and information asymmetry, which could be statistically represented by

equation [3]:
z = α + α y
+ ∑ α x + u

[3]
where zit represents the level of information asymmetries of firm i in year t; yit-1
represents the corporate disclosures of firm i in year t-1; xj represents the j control
variables, such as company size, leverage, market-to-book ratio, and the forecast
dispersion, whose effects on information asymmetry have been extensively tested by
previous literature; and uit is the disturbance term, which involves any changes that
occur to the information asymmetry of firm i in year t (z ) that cannot be explained by
the level of disclosures (y

) of firm i in year t-1, and control variables (x ). We are

interested in α that is the change in information asymmetry under variations in
corporate disclosures:
∂z
=
α
∂y
In this respect, several authors have found a negative association between
corporate disclosures and information asymmetry representing the latter by the bid–ask
spreads, share price volatility or stock liquidity trading volume (Welker, 1995; Healy et
8
al., 1999; Leuz & Verrecchia, 2000; Bertomeu et al., 2011). So, we expect an inverse
relation between asymmetries and disclosures:
∂z
=
α < 0
∂y
Relation 2 of Figure 1, i.e. how information asymmetry is associated with the
cost of capital, could be statistically represented by equation [4]:
r = θ + θ z + ∑ θ x + e

[4]
where rit represents the cost of capital of firm i in year t; zit represents the level of
information asymmetries of firm i in year t; xj represents the j control variables, such as
company size, leverage, market-to-book ratio, and the forecast dispersion, whose effects
on the cost of capital have been extensively tested by previous literature; and eit is the
disturbance term, which involves any changes that occur to the cost of capital of firm i
in year t (r ) that cannot be explained by the level of information asymmetry (z ) and
control variables (x ). θ is the change in the cost of capital under variations of

asymmetries,
∂r
= θ
∂z
From prior evidence, we expect a direct and positive relation between
information asymmetry and the cost of capital; that is, a firm with a higher level of
information asymmetry tends to face a higher cost of equity capital (Easley and O’Hara,
2004; Lambert et al., 2011, He et al., 2013). So, a positive relation is expected:
∂r
= θ > 0
∂z
9
Nonetheless, these previous authors consider information asymmetry as a
component of the cost of capital, but they fail in directly estimating that cost. To
overcome such limitation, equation [3] is substituted in equation [4] as follows:
r = θ + θ (α + α y

+ α x + u ) + θ x + e

r = (θ + θ α ) + θ α y

+ θ (α +θ )x + (θ u + e )

r = β + β y
+ ∑ β x + ε

[5]
In equation [5] the constant term is β = θ + θ α , the relationship between
information quality and cost of capital is β = θ α , the relationship between the j-th
control variable and cost of capital is β = θ (α + θ ), and the error term is ε =
θ u + e . Equation [5] allows relation 3 represented in the Figure 1 to be studied,
since we can observe the change in cost of capital due to a variation of corporate
disclosures:
∂r
= β = θ
α
∂y
As we can observe, the effect of disclosures (y) on the cost of capital (r) is
broken down into two different impacts: θ , which is the effect of information
asymmetries on cost of capital, and α , which is the effect of disclosures on
asymmetries. Following findings of Lambert et al. (2011) and He et al. (2013), we
expect θ > 0, suggesting that information asymmetries are positively related to the
cost of capital; and according to Welker (1995), Healy et al. (1999), and Leuz and
Verrecchia (2000), among others, we expect

α < 0, suggesting a negative link between
corporate disclosures and information asymmetry. In turn, we expect a negative
10
association between disclosures and the cost of capital, i.e. θ
α < 0, according to
Richardson and Welker (2001), Hail (2002), Francis, LaFond et al. (2005b), Francis et
al. (2005), Li (2010), and Petrova et al. (2012), among others. These expectations on
the relationship between corporate disclosures, information asymmetry, and the cost of
capital are represented in the following propositions:
!"
Proposition 1: Information asymmetries reduce with corporate disclosures:!# =
α < 0
= θ > 0
!$
!"
Proposition 2: Cost of capital increases with information asymmetries:
Proposition 3: Cost of capital reduces with corporate disclosures, by the mediation of
= β = θ
!$
α < 0
!#
information asymmetries:
Empirical approach: sample, variables and empirical models
Sample
The data source was formed based on an initial selection of the world’s largest
2,000 listed firms provided by Forbes,1 a selection that is widely employed in prior
research. We based the composition of our sample on the information that is available in
two databases: (i) Thomson One Analytics2 for the accounting and financial information
(e.g. total assets, leverage, market-to-book ratio, etc.) provided in consolidated financial
statements; and (ii) the I/B/E/S database, for analysts forecasts data.
1
The FORBES Global 2000 is a comprehensive list of the world’s largest, most powerful public
companies, as measured by revenues, profits, assets and market value.

2
Thomson One Analytics delivers a broad range of financial content. This database of finance data
integrates Datastream, Worldscope, Extel, IBES, Compustat, IDC Pricing and A-T Financial News. It is
provided by Thomson Reuters.
11
The sample procedure is as follows: for the initial largest 2,000 firms, we
included their economic, financial and accounting data obtained from Thomson One
Analytics, excluding financial firms since their specific characteristics in terms of equity
make them non-comparable with non-financial firms (La Porta et al., 2002). This
exclusion meant that our sample was composed, at this stage, of 1,560 international
non-financial listed companies. Then, we combined information of these firms with data
available on the I/B/E/S database, resulting in a final sample composed of 1,260
companies in the period 2007-2014. The sample is unbalanced, with 7,532 observations,
because not all companies are in all periods. The firms develop their activity in different
sectors (basic materials, industrial, utilities, services industry, construction, retail,
transportation, and telecommunications), and they are from different countries
(Belgium, Canada, Denmark, Finland, France, Germany, Hong-Kong, India, Italy,
Japan, the Netherlands, Norway, Spain, Sweden, Switzerland, the UK, and the USA).
This allows checking sensitivity based on different institutional contexts.
Table 1 shows the sample distribution by year, country, and activity sector. As
we can observe, the number of observations increases year by year, from 707 in 2007, to
1,007 in 2014, due to the availability of information in the different databases.
According to geographic diversity, almost 40 percent of observations correspond to the
USA, following by the UK with around 11 percent of observations. Among the activity
sectors, the industrial sector (i.e. manufacturing firms) are the greatest represented in the
sample (48.2% of observations). Basic materials, utilities, construction, transportation,
and others activity sectors represent about the 3 – 5 percent of the sample, and retail
companies and those companies that offer services industry represent the 9 – 10 percent
of the firms sample.
<Insert Table 1 here>
12
Measure of information asymmetry
Among the great diversity of information asymmetry proxies (e.g. bid–ask
spreads, share price volatility, and stock liquidity trading volume), we select the
analysts’ forecast accuracy to represent the level of information asymmetry (variable
called IA). Forecasts can be precisely measured for earnings or revenues, and it is
possible to determine whether they precede or lag changes in specific variables (Healy
& Palepu, 2011). These characteristics make them powerful proxies, although they have
also some limitations; more concretely, forecasts could be easily verified by investors
through actual earnings realizations. Nevertheless, analysts’ forecast accuracy has been
widely used by previous studies (e.g. Lang & Lundholm, 1996; Marquardt & Wiedman,
1998; Lang & Lundholm, 2000; Martínez-Ferrero et al., 2015a; Cui et al., 2016).
The IA variable is calculated as follows:
|EPS −mean of forecasted EPS|

%& =
P
where EPS are the expected earnings per share of firm i in year t and Pit is the
shares price of firm i in year t, measured both at the end of the fiscal year. Lower
absolute errors suggest greater availability of information, and therefore, lower
information asymmetries (Maquardt & Wiedman, 1998).
Measure of cost of capital
The cost of equity capital is the minimum rate of return equity investors require
for providing capital to the firm (Botosan, 2006). The choice of the measure of cost of
capital is a decision widely discussed by the previous literature. There is no consensus
on what is the ideal measure or how evaluate the quality of the measurement.
Nontheless, Botosan and Plumlee (2005) and Botosan et al. (2011) – after analyzing
13
various ex ante measures of the cost of capital – recommended the price–earnings–
growth (PEG) model proposed by Easton (2004) as one of the best proxies.
Following this recommendation and according with Botosan and Plumlee
(2005), Francis et al. (2004), Francis et al. (2008), Blanco et al. (2010), El Ghoul et al.
(2011), and Martínez-Ferrero et al. (2014), we use the PEG ratio as a measure of cost of
equity capital, based on the model proposed Ohlson and Juettner-Nauroth (2005), and
operationalized by Easton (2004). This measure imposes the assumption of zero growth
in abnormal earnings beyond the forecast horizon and is more useful since it isolates the
effect of growth and cash flow (Hail & Leuz, 2006).
The rPEG ratio is calculated as follows:
EPS; − EPS<
6789 = :
P
where EPSt is the expected earnings per share t years in the future and P0 is the current
market price of the firm’s stock. Following Blanco et al. (2010), we use five years
long-term growth rates from I/B/E/S to calculate these earnings per share forecasts in
years 4 and 5. The model requires positive four-year-ahead and five-year-ahead
earnings forecasts as well as positive change in the earnings forecast. We use long-term
earnings forecasts (EPS; and EPS< ) following Botosan and Plumlee (2005), instead of
EPS and EPS , because if EPS is less than EPS , we cannot solve the model and limit
our sample. However, since EPS; always exceeds EPS< , such a problem is avoided.
Botosan and Plumlee (2005) studied different measures of cost of capital and
concluded that the estimates based on the PEG ratio proposed by Easton (2004) are
consistently and predictably related to market risk, leverage risk, information risk, firm
14
size, book-to-price and growth. They argue that this ratio dominates the alternative
measures of cost of capital and recommend using PEG ratio in studies that require firm-
specific cost of equity capital.
Measures of corporate disclosures quality
In general, extant literature noted that overall corporate disclosure quality is
linked to information asymmetry/cost of capital. However, overall disclosure quality is
a nebulous construct that incorporates both financial and non-financial attributes

(Bhattacharya et al., 2013). Thus, it would be proper to take into account such attributes
independently.
To our knowledge, Richardson and Welker (2001) are the only authors who
manage financial and social disclosures separately; they create two indexes, one for
representing financial disclosures and the other for social information, by using the
scores published in 1990, 1991, and 1992 in the Society of Management Accountants of
Canada (SMAC)/University of Quebec at Montreal (UQAM) annual reports, testing
their validity. However, this information is only available for North American firms. In
this paper, with the aim of considering financial and social disclosure quality in
different countries, we create two different variables, called FRQ and SRQ.
FRQ represents the financial reporting quality. According to Martínez-Ferrero et
al. (2015b), to create this proxy we use the accruals quality model proposed by Ball and
Shivakumar (2006). These authors suggest that nonlinear accrual models, which
incorporate the timely recognition of losses, perform better than linear models. Hence,
they consider a current-year cash flow dummy and its interaction with the level of
previous, current and future cash flows.
15
∆>?@A D?E@AFG D?E@A D?E@AIG JKLM@A NNL@A
BC@A
= β + β BC@AFG
+ β BC@A
+ βH BC@AIG
+ β< BC@A
+ β; BC@A
+ βO DOCF +
D?E@A
βT BC@A
∗ DOCF + ε
where Δ(·) is the change from t-1 to t; OCFi is the operating cash flow in t, t-1 and t+1;
REV are revenues of firm i in year t; PPE is the plan, property and equipment assets
of firm i in year t; DOCF is a dummy variable that takes the value 1 for the negative
cash flows and 0 otherwise; and WC is the working capital accruals calculated as:
WC = Accounts Receivable + Inventory − Accounts Payable

− Taxes Payable + Other Assets
For each firm, accruals quality is represented by the discretionary component of
accruals adjustment, which is represented by the absolute value of the disturbance term
in equation [6], ε . The lower the level of |ε |, the higher the accruals quality. Finally,
FRQ is represented by the inverse value of |ε |:
1
FRQ =
|ε |
Financial and accounting disclosures have been widely studied in the extant
literature on cost of equity capital (e.g. Bhattacharya et al., 2003; Francis et al., 2004,
2005; Barth et al., 2005; Apergis et al., 2011, among others). Quality of financial
information decreases the estimation risk, information asymmetries, and then, the
adverse selection risk that determines the cost of capital. But social and environmental
disclosures have not been extensively analyzed; nevertheless, the rapid growth in
socially responsible investments, as well as publication of international standards for
CSR reports, such as the Global Reporting Initiative (GRI) guidelines, have led to the
idea that financial reporting may overlook relevant issues that impact on corporate
16
performance (Cohen et al., 2012). Cohen et al. (2011) posited that investors use non-
financial information, such as CSR disclosures, when making their investment
decisions. Results from their survey showed an increasing interest in CSR information
by retail investors. Non-financial information is not directly related to the balance sheet,
but it offers relevant facts for investor decision-making (Chua, 2006).
Very few studies have been focused on CSR information. Angel and Rivoli
(1997) noted that when firms are excluded from portfolios for social or ethical reasons,
the cost of capital tends to increase (Richardson et al., 1999). Cormier et al. (2011)
empirically found a negative link between social and environmental disclosures and
information asymmetry, measured by the bid–ask spreads as well as share price
volatility. El Ghoul et al. (2011) empirically show that firms with a higher CSR score
showed a lower financing cost, by using a sample that represented 2,809 companies
between 1992 and 2007. More recently, findings obtained by Hung et al. (2013) suggest
that mandatory CSR disclosure leads to a decrease in information asymmetry, by using
a difference–indifferences method and a propensity score matching procedure for a
sample of Chinese listed firms from 1996–2010. Recently, Cui et al. (2016) document
similar results for a sample of US firms from 1991-2010.
However, aside from Richardson and Welker (2001), we have not found any
study that jointly analyzes financial and social disclosures, in relation to information
asymmetry/cost of capital. To represent social reporting quality, we create a proxy
called SRQ, by using the triangulation of discourse analysis, i.e. we consider both
quantity and quality of CSR disclosures. Quality is determined on the basis of
international standards for CSR information, specifically the GRI guidelines. Through
the comparison of the information contained in CSR reports with the recommendations
17
of GRI standards, we can determine the extent to which this information is
comprehensive, comparable and harmonized.3
Silence about CSR activities may be difficult to interpret by stakeholders
(Richardson et al., 1999), since it could be explained by no CSR activities to report, or
by bad CSR behavior. However, we consider that focusing only on the quantification of
the number of GRI indicators included in the CSR reports is an important limitation in
view of the fact that companies only incorporate the indicators that show their best CSR
performance. Thus, our proposal improves on previous approaches by incorporating

into the quantification of the GRI indicators the requirement to disclose a minimum
number of indicators according to the GRI application levels A, B and C. Companies
should incorporate the same indicators and number of these indicators at any of these
levels, assuring comparability between companies and between years. This condition
determines the relevance and usefulness of the CSR information. Moreover, the
requirement to disclose the same indicators means that companies have no capacity to
decide which indicators to report and they are obliged to disclose both their good and
bad performance.
SRQ takes values between 0 and 100, as is shown in Table 2. We examined
manually the CSR reports of every sample company and we assigned values (0, 25, 50,
75 and 100) according to the level of specification and harmonization. Value 0 is
assigned to firms that do not disclose CSR information; a score of 25 is assigned to
firms that disclose CSR information but it does not comply with the GRI guidelines;
3
According to GRI guidelines, information about CSR should be: (i) global, i.e. reporting on all aspects
of the company (financial, economic, sustainability, etc.); (ii) comparable, so it must be numeric and
monetary; and (iii) harmonized so that all parties can understand the information, regardless of where the
company is located.
18
scores of 50, 75, and 100 are assigned to firms that disclose CSR information according
to level C, B, and A of GRI guidelines, respectively.
Table 3 shows the distribution of SRQ scores by country and by activity sectors.
As we can see in Panel A, Netherland, Italy, and Norway are countries with companies
that hold the lower scores for CSR information. Around 75 percent of observations from
those countries take the value 0, meaning that those firms do not publish a CSR report.
Among firms that disclose CSR information, very few companies (none in Norway)
follow the GRI guidelines’ level A, i.e. the higher quality level. Similarly, firms from
Belgium, the USA and the UK tend to disclose few CSR data, and those firms that
disclose such information do not use GRI standards, or they use GRI guidelines but with
the lower quality levels. In contrast, almost 22 percent of observations from Finland
publish their CSR report with the higher level of GRI guidelines. In general terms, firms
from Finland tend to show the best scores.
In relation to activity sectors, all of them tend to have a similar pattern; few
firms tend to disclose CSR reports according to GRI standards. The higher quality of
CSR disclosure practices are developed by firms that operate in utilities and basic
materials sectors; and the lower quality of disclosures practices could be seen in
services industry and retail sectors. In general, energy, oil, and gas sectors have been
characterized as more environmental sensitive sectors, that face stronger stakeholders’
demands for greater transparency (Frynas, 2010; Outtes-Wanderley et al., 2008); thus,
companies operate in these industries tend to report larger CSR information (Adams et
al., 1998; Clarke & Gibson-Sweet, 1999; Patten, 1991; Branco & Rodrigues, 2008).
19
Control variables
Results are controlled by different corporate characteristics, whose impacts on
information asymmetry/cost of capital have been studied extensively in the literature
(e.g. Richardson & Welker, 2001; Hail, 2002; He et al., 2013; Cho et al., 2013, among
others). Specifically, we control by: (i) firm size (Size), represented by the natural
logarithm of total assets; (ii) firm leverage (Leverage), measured by the ratio of total
debt to total equity; (iii) growth opportunities (Growth), often represented by the
market-to-book ratio – i.e. ratio between the market value of the company and the book
value; and (iv) dispersion of analyst forecasts (Dispersion), defined as the coefficient of
the variation of one-year-ahead analyst forecasts of earnings per share.
In addition, results are controlled by activity sector, country, and temporal
moment. Operationally, Yeart are t dummy variables that represent the t years of the
sample, from 2007 to 2014; Countryj are j dummy variables that represent the different
j countries of the sample – i.e. Belgium, Canada, Denmark, Finland, France, Germany,
Hong-Kong, India, Italy, Japan, Netherland, Norway, Spain, Sweden, Switzerland, the
UK, and the USA; and Industryk are k dummy variables that represent the different k
activity sectors in which the companies of the sample operate – i.e. basic materials,
industrial, utilities, services industry, construction, retail, transportation,
telecommunications, and others.
Table 4 shows mean values and standard deviations for all variables involved in
the empirical models (financial and social reporting quality, information asymmetry, the
cost of capital, firm size and leverage, market-to-book ratio, and analysts’ forecast
dispersion). In addition, we can see in the same table bivariate correlations among all
these variables. Correlations suggest a negative relation between corporate disclosures,
20
on the one hand, and information asymmetries and the cost of capital, on the other hand;
in addition, there is a positive link between asymmetries and the cost of capital. These
relations will be empirically tested below. Regarding control variables, although
correlations are statistically relevant, they are not very large, except correlation between
leverage and market-to-book ratio (0.4101). For these variables we obtained a variance
inflation factor (VIF) of 1.2, which is lower than 10 that is the usual maximum level of
VIF recommended in the literature (Hair et al., 1995). Thus, multicollinearity problems
will be not involved in our models.

Models for the empirical analysis
Analysis of propositions could be tested by estimating equations [3], [4], and [5],
through the following econometric models. Model [6] corresponds to equation [3],
which relates disclosures quality and information asymmetry; equation [4] is
represented by the model [7] that links information asymmetry with the cost of capital;
and model [8] represents equation [5], which associates disclosure quality and the cost
of capital. In addition, model [9] will be used to test the mediator role between
disclosure quality and the cost of capital, as is represented in Figure 1, analyzing the
change in the effect of corporate disclosures on the cost of capital when information
asymmetry variable is also entered in the same model.
%& = α + α efg
+ α hfg
+ αH Size + α< Leverage + α; Growth +
αO Dispersion + ∑<
T α Country + ∑n; βn Industryn + ∑H< β Year + u [6]
HH <

6789 = θ + θ %& + θ Size + θH Leverage + θ< Growth + θ; Dispersion +
∑H
O θ Country + ∑n< βn Industryn + ∑HH β Year + e [7]
H <

21
6789 = β + β efg
+ β hfg
+ βH Size + β< Leverage + β; Growth +
βO Dispersion + ∑<
T β Country + ∑n; βn Industryn + ∑H< β Year + ε [8]
HH <

6789 = λ + λ efg
+ λ hfg
+ λH %& + λ< Size + λ; Leverage +
λO Growth + λT Dispersion + ∑;

q λ Country + ∑nO λn Industryn +
H<

∑<
H; λ Year + ϵ [9]
FRQ represents the financial reporting quality, calculated by using the accruals
quality model proposed by Ball and Shivakumar (2006); SRQ represents the social
reporting quality, and it takes values 0, 25, 50, 75, and 100 according to harmonization
of the CSR report in relation to the GRI guidelines; rPEG is the price–earnings–growth
ratio to measure the cost of capital based on the model proposed Ohlson and Juettner-
Nauroth (2005), and operationalized by Easton (2004); IA is the proxy of information
asymmetry calculated by the analysts’ forecast accuracy; Size represents the firm size
calculated as the natural logarithm of total assets; Leverage is measured by the ratio of
total debt to total equity; Growth represents the firm’s growth opportunities calculated
as the market-to-book ratio; and Dispersion is the dispersion of analysts’ forecast,
defined as the coefficient of variation of one-year-ahead analyst forecasts of earnings
per share; Countryj are j dummy variables that represent the different j countries of the
sample; Industryk are k dummy variables that represent the different k activity sectors
of the sample; and Yeart are t dummy variables that represent the t years of the sample,
from 2007 to 2014.
Sub-index i represents sample firms, i = [1, 1260], and t represents sample years,
t = [2007, 2014]. α, θ, and β are estimated coefficients using an estimator for panel data.
The use of a panel data set allows us to overcome the limitations of cross-sectional
models, especially their low explanatory capacity, which is closely related to the period
22
of analysis considered. Panel data models provide greater consistency and explanatory
power than cross-section models because we consider several time periods. In addition,
this technique allows controlling for unobservable heterogeneity, which refers to the
particular behavior and characteristics of sample firms, different among firms but
invariant over time. These characteristics are difficult to measure because they are
unobservable to the researchers, but if we do not take them into account our empirical
results will be biased. Unobservable heterogeneity is controlled by modeling it as an
individual effect. Thus, disturbance terms in previous models, i.e. eit, uit, ɛit, and ϵit are
broken down into two parts: ηi, which represents unobservable heterogeneity; and µit,
which is the classical error component, variable over firms and years.
Another problem for empirically estimating previous models is endogeneity that
might exist among disclosures, information asymmetry, and the cost of capital (e.g.
Welker, 1995; Leuz & Verrecchia, 2000; Cormier et al., 2011; Bhattacharya et al.,
2013). If the selection of disclosure policy is a strategic decision considering costs
versus benefits of increasing disclosures, then proposed models might suffer from self-
selection bias (Hail, 2002). Statistically, endogeneity may be defined as the existence of
a correlation between the explanatory variables and the error term, due to the existence
of causality among dependent and independent variables (Wooldridge, 2010).
Therefore, it is necessary to take into account these two econometric problems,
unobservable heterogeneity, and endogeneity problems.
The empirical results obtained by using STATA 11 are included in Tables 6 and
7. Initially, the fixed- or random-effects estimator could be used to estimate our models,
but the errors must be conditionally homoscedastic and not serially correlated. Thus,
firstly, we test whether our model presents heteroscedasticity and serial correlation
problems using the Breusch–Pagan test and the Wooldridge test, respectively. The p-
23
values obtained for each test are 0.0000, which means that we must reject the null
hypotheses of homoscedastic errors and no serially correlated errors.
Another problem, named endogeneity, could appear in our model. Statistically,
endogeneity may be defined as the existence of a correlation between the explanatory
variables and the error term due to the existence of causality among the dependent and
the independent variables (Wooldridge, 2010). In our models, endogeneity is an
intrinsic problem since there are relationships in the both directions among the three
main variables: corporate disclosures, information asymmetry, and the cost of capital.
They are intrinsically related from the economic point of view. In addition,
autoregressive models introduce endogeneity by themselves.
The endogeneity problem has been addressed by using instrumental variables
methods embedded in the GMM as special cases. Specifically, models [6], [7], and [8]
have been estimated by using the two-step system estimator with adjusted standard
errors proposed by Arellano and Bond (1991), by using the two- to four-period lags of
the independent and control variables as instruments. It has been shown that these
lagged values of the independent variables as instruments are uncorrelated with the error
term when the estimator is derived (Arellano & Bond, 1991; Blundell & Bond, 1998).
Moreover, they contain information on the current value of the variable, since there is
frequently a delay between the decision taken by an individual and its actual realisation
(Pindado & Requejo, 2015).
Empirical results
Validation of financial and social reporting quality proxies
Before performing empirical models, we develop a test to examine the validity
of our financial and social disclosure quality. According to Richardson and Welker
24
(2001), one way to validate these empirical proxies is to examine the relation between
FRQ and SRQ variables and other variables whose effects on disclosure policy have
been previously analyzed. In particular, financial and social disclosures have been
previously explained by firm size, profitability, and leverage, controlling for country,
industry, and temporal moment (e.g. Patten, 1991; Deegan & Gordon, 1996; Botosan,
1997; Francis et al., 2004; Cormier et al., 2011; García-Sanchez et al., 2014). Firm size
is measured by the logarithm of total assets (called Size); profitability is represented by
the return-on-assets ratio (called Profitability); and leverage is calculated as ratio of

total debt to total equity (called Leverage). Accordingly, we estimate the following two
models:
efg = γ + γ Size + γ Profitability + γH Leverage + ∑

< γ Country +
∑H
n γn Industryn + ∑H γ Year + ϵ
Hq
[10]
hfg = γ + γ Size + γ Profitability + γH Leverage + ∑

< γ Country +
n γn Industryn + ∑H γ Year + ϵ

∑H Hq
[11]
Empirical results for models [10] and [11] are shown in the annex 1 (table A1),
which have been obtained by using the GMM estimator and ordered probit estimator for
panel data, respectively. SRQ is an ordinal variable, which took values from 0 to 100
according to the quality of CSR information; this leads us to use an appropriate
estimator that takes into account the special characteristic of the dependent variable.
Results indicate that firm size, profitability and leverage are statistically relevant
in explaining FRQ and SRQ, and all of them impact positively on both dependent
variables, such as bivariate correlation suggested. According to Richardson and Welker
(2001), the fact that our disclosure proxies are strongly related to variables suggested by
25
previous literature as determinants of disclosures indicates that variation in our
empirical proxies captures variation in financial and social disclosures.
Multivariate analysis
Results from models 6 to 9, which empirically show the relation between
disclosure quality, information asymmetry, and the cost of capital are shown in Table 5.
Model 6 relates information asymmetry and reporting quality. Both FRQ and
SRQ show negative coefficients, which are statistically relevant at 99.9 and 95 percent
confidence level, respectively. As we suggested in Proposition 1, disclosure quality is
negatively related to information asymmetries – both financial and social disclosures.
Since corporate disclosures essentially turn private into public information, then
differences between informed and uninformed investors in the market decrease
(Diamond & Verrecchia, 1991).
In addition, these results extend the empirical findings of Welker (1995), Healy
et al. (1999), and Leuz and Verrecchia (2000), who found a negative link between
financial disclosures and bid–ask spreads, as proxy of asymmetries, and the results
obtained by Bhattacharya et al. (2013), who showed that poor earnings quality is
associated with higher information asymmetries, by using a sample of NYSE and
NASDAQ firms from 1998–2007. Our results are in agreement with them, but we
enlarged the sample to the international environment.
In the case of social disclosures, we found a negative link between SRQ and
asymmetries, similarly to Cormier et al. (2011), who found a negative association
between social and environmental disclosures and the bid–ask spreads and the share
price volatility. This result is very relevant since it suggests that CSR disclosures are
essential from the investment perspective (Cohen et al., 2011), so higher quality
26
information is very much appreciated by investors in evaluating opportunities in the
market. Firms will be interested in CSR disclosures because, as we found previously,
the reduction of asymmetries among investors tends to also reduce the cost of capital.
In addition, from regressing Model 7, we can observe that IA impacts positively
on rPEG, being statistically relevant at 99.9 percent confidence level. This shows the
expected positive link between information asymmetries and the cost of capital
(Proposition 2), suggesting that uninformed investors will hold assets for which their
information disadvantage is less, reducing the price of assets with a higher information
asymmetry, which in turn increases the cost of capital (Lambert et al., 2011). Our result
adds empirical findings to theoretical models proposed by Easley and O’Hara (2004),
and Lambert et al. (2011), as well as corroborating findings obtained by He et al. (2013)
in a sample of firms listed on the Australian Securities Exchange.
However, although all these authors consider information asymmetry as a
component of the cost of capital, they fail to directly estimate the effect of disclosures
on the cost of equity capital. To overcome this limitation, we estimate Model 8, whose
results also are shown in Table 5. We can see that FRQ and SRQ impact negatively on
the cost of capital, being statistically relevant at 99.9 percent. These results suggest that
financial and social disclosure quality is negatively related to the cost of capital, as we
expected in Proposition 3. Our finding is partially in agreement with Richardson and
Welker (2001), since they also found a negative link between financial disclosures and
the cost of capital, but a positive link between social disclosures and the financing costs.
The first association (FRQ - rPEG) has been previously suggested by Easley and
O’Hara (2004)’s and Lambert et al.’s (2007) theoretical models: since quality of
information affects prices, how information is provided to the markets is highly
27
important for the company, moving the cost of capital closer to the risk-free rate (Easley
and O’Hara, 2004; Lambert et al., 2007). Similarly, Bhattacharya et al. (2003), Francis
et al. (2004), and Barth et al. (2005) showed that firms with poor earnings attributes
(e.g. accruals quality, transparency, conservatism, smoothness, etc.) tend to have a
higher cost of equity capital. Our findings are in accordance with them, but extant
previous literature fails in considering only financial information. This association is
empirically shown in Table 5 (SRQ - rPEG), suggesting a negative link between social
disclosure quality and the cost of capital. This is contrary to Richardson and Welker
(2001)’s findings, but it is in agreement with what those authors had expected to find.
The poor economic conditions of their sample, since it focused on Canadian firms from
1990–1992, was the reason they suggested to explain the contrary results they obtained.
Our sample overcomes such a limitation, and we evidence the relevant role of both
financial and social information in terms of cost of capital.
Mediator role of information asymmetry
Finally, previous findings suggest information asymmetry could play a mediator
role between disclosure quality and the cost of capital, as is represented in Figure 1.
Mediation is tested by using the procedure of Baron and Kenny (1986) that has been
extensively used previously in a wide range of areas of research. This procedure
requires to know: (i) the link between independent variables (FRQ and SRQ) and the
mediator variable (IA) – i.e. model 6; (ii) the link between mediator and independent
variables (IA, FRQ, and SRQ) and dependent variable (rPEG), separately – i.e. models 7
and 8, respectively; and (iii) the link between mediator and independent variables (IA,
FRQ, and SRQ) and dependent variable (rPEG), jointly – i.e. model 9. Results for steps
(i) and (ii) have been commented previously; results for model 9 are also shown on
table 5.
28
We found that information asymmetry is positively related to rPEG, and financial
and social disclosure quality is negatively related to rPEG; every coefficient is
statistically relevant at 99.9 percent. According to Baron and Kenny (1986), for
information asymmetry can be considered mediator in the relationship between
disclosures quality and the cost of capital, the association between independent
variables (FRQ and SRQ) and rPEG must be lesser in absolute values than the original
effect in the second step (Model 8). Effectively, coefficients for FRQ and SRP are
lower than those obtained in Model 8, meaning that information asymmetry plays a
mediator role in the relation between financial and social disclosure quality and the cost
of capital, such as Proposition 3 suggested. The negative effect of corporate disclosures
on the cost of capital is due to the reduction of information asymmetry.
Sensitivity analyses
Since firms included in the sample are from different countries, results could be
biased depending on some institutional and contextual issues. In order to complement
our previous findings we additionally check whether our core evidence that information
asymmetry mediate the relationship between corporate disclosures and cost of capital
varies according to differences in accounting standards and other institutional factors,
namely investor protection. Empirical results from these sensitivity analyses are
reported in Table 6 and 7.
Firstly, if accounting standards are important in determining financial reporting
quality (Levitt, 1998), they could affect in turn information asymmetries and the cost of
capital. Debate on the competition between the International Financial Reporting
Standards (IFRS) and US General Accepted Accounting Principles (GAAP) has
29
developed from several years ago (Leuz, 2003). IFRS is expected to improve accounting
quality, especially through the reduction of earnings management (Barth et al., 2008;
Daske & Gebhard, 2006). In contrast, Callao and Jarne (2010) suggested that earnings
management has intensified since the adoption of IFRS in Europe. But these findings
have been refined by other authors. Chen et al. (2010) reported lower earnings
management, lower absolute discretionary accruals, and higher accruals quality after
IFRS adoption in the EU, although they also found that firms engage in more earnings
smoothing. In terms of information asymmetry, Leuz (2003) did not find relevant
differences between IFRS and US GAAP, although IFRS opponents argue that US
GAAP is superior in terms of detail and rigor.
New results are obtained by restricting the sample to those companies that apply
IFRS only (table 6). These findings are similar to those obtained previously for the full
sample – i.e. corporate disclosures tend to reduce the cost of capital by reducing
information asymmetries. In other words, information asymmetry is a mediator in the
relationship between corporate disclosures and cost of capital independently of
accounting standards. These findings support results of Leuz (2003), suggesting that
IFRS are not superior to other accounting standards in terms of reduction information
asymmetry, and in turn in reducing the cost of capital. This lead us to think whether
reporting quality is determined by other institutional factors rather than by accounting
standards.
Due to the difficulties of categorising countries according to their institutional
context, we adopt the approach of La Porta et al. (1998) by identifying institutional
factors that characterise the firms’ country of origin, namely investor protection, which
involves preventing the rights of shareholders by law (Leuz et al., 2003). The level of
investor protection is important for our study because it has been identified as one of the
30
main institutional factors affecting corporate decision making (Shleifer & Vishny 1997).
Companies in countries with higher levels of investor protection prioritize shareholder
interests, and the effect of corporate disclosures on the cost of capital can diverge. In
addition, information asymmetries are bigger in companies located in countries where
investor protection is low (La Porta et al. 1999) and accounting practices are more
aggressive in such contexts (Chih et al. 2008; Scholtens & Kang 2012). Thus, the
moderation role of information asymmetry found previously could be moderated by the
level of investor protection.

Following Hillier et al. (2011), we use three sub-indices to represent the level of
investor protection that stem from the country-level governance indices of La Porta et
al. (1998): (i) the legal tradition – i.e. common law and civil law countries; (ii) anti-
director rights index; and (iii) the mechanism of law enforcement, based on efficiency
of the judicial system, and law and order. Finally, we proxy investor protection by
aggregating these indices with the factorial methodology, obtaining a principal factor
called IP. Finally, IP is interacted with FRQ, SRQ, and IA, with the aim of testing
models 6 to 9 in different investor protection environments.
Empirical results are shown on table 7; again, they suggest that corporate
disclosures tend to reduce the cost of capital by reducing information asymmetries.
Focusing on interactions coefficients, we can see that results for FRQ, SRQ, and IA are
enlarged when the level of investor protection increases. Our findings suggest that
information asymmetry mediate the relationship between corporate disclosures and the
cost of capital, and this role is enlarged when the level of investor protection is high.
These findings are according to previous literature that found that agency problems are
lower in companies located in countries with strong investor protection (La Porta et al.,
1999).
31
Similarly, our findings suggest that social reporting quality also increases with
the level of investor protection, contrary to Simnett et al. (2009) and Dhaliwal et al.
(2012). They argue that more stakeholder oriented countries (with low levels of investor
protection) make greater emphasis on corporate responsibilities towards all
stakeholders, and therefore, social reporting quality increases. Our findings suggest that
social reporting quality is also relevant for shareholders because they use this
information for taking investment decisions (Cohen et al, 2011). Strong protection
limits insiders’ ability to acquire private control benefits (Leuz et al. 2003), for instance,
by increasing corporate reporting, both social and financial disclosures.
Conclusions
This study proposes a new insight into the literature by evidencing the relation
between corporate disclosures quality and the cost of capital, and highlighting the role
of information asymmetry as a mediator component in such relation. Firms that increase
their financial and social disclosure quality tend to reduce information differences
(asymmetries) among investors in the market. Then, from the “liquidity perspective,”
the price of assets with lower information asymmetries increases, thus this reduces the
cost of capital by improving liquidity. From the “estimation risk perspective,” a
reduction of information differences decreases at least part of the estimation risk
component of the cost of capital, leading to a move closer to the risk-free rate (Lambert
et al., 2007). Moreover, sensitivity checks have been performed, indicating that
accounting standards do not affect the mediator role of information asymmetry, at least
in terms of reducing the cost of capital thanks to corporate disclosures quality.
32
Nevertheless, other institutional factors, such as the level of investor protections seem to
enlarge the mediator role of information asymmetry on the relationship between
disclosures quality and the cost of capital.
Our study contributes to multiple streams of research as follows. Firstly, we
respond to the research avenue proposed by Dhaliwall et al. (2014) of exploring the
underlying mechanism through which corporate disclosures affect the cost of capital.
Concretely, despite of several studies have supported the fundamental role of
asymmetries in the market (e.g. Easley & O’Hara, 2004; Diamond & Verrecchia, 1991),
any previous study broke down the relation between disclosures and the cost of capital
into two parts, considering information asymmetries as a mediator in such relation.
Information differences in capital markets are the core of functioning, injecting more or
less liquidity and moving traders for one asset to another, and this paper highlights the
great importance of such differences.
In addition, we contribute to the literature about the benefits of disclosure (Li,
2010; Dhaliwal et al., 2011; Cho et al., 2013; Cui et al., 2016), considering both
financial and social information. On the one hand, several studies talk about corporate
disclosures (e.g. Diamond & Verrecchia, 1991; Botosan, 1997; Sengupta, 1998; Healy
et al., 1999; Bloomfield & Wilks, 2000; Healy & Palepu, 2001; Easley & O’Hara, 2004)
without considering that such information includes both financial and non-financial
attributes, and it is not proper to consider all of them jointly (Bhattacharya et al., 2013).
On the other hand, other studies are focused on specific aspects, such as
voluntary information (e.g. Hail, 2002; Petrova et al., 2012, among others), mandatory
information (e.g. Core et al., 2015); different attributes of earnings (e.g. Bhattacharya et
al., 2003; Francis, et al., 2004, 2005b; Barth et al., 2005; Bhattacharya et al., 2013,
33
among others), accounting information (e.g. Leuz & Verrecchia, 2000; Lambert et al.,
2007; Li, 2010; Apergis et al., 2011, among others) or non-financial information (e.g.
Richardson et al., 1999; Cormier et al., 2011; El Ghoul et al., 2011; Cho et al., 2013;
Hung et al., 2013, among others). However, we analyze both financial and non-financial
disclosures, considering the possible differences between them, which shed light in
identifying the nature of disclosures. To our knowledge, Richardson and Welker (2001)
is the only paper that takes into account financial and social disclosures with the aim of
testing whether they are related to the cost of capital. However, our study differs in
several aspects: they use a sample of Canadian firms from 1990–1992 to analyze the
relation between disclosures and the cost of equity capital, without considering
specifically the role of information asymmetry; in contrast, we use an international
sample from 2007–2014, and we highlight the role of information asymmetry on the
relationship between corporate disclosures and the cost of capital.
From the above, we contribute so to voluntary CSR reporting literature
(Dhaliwal et al. 2011; Martínez-Ferrero et al., 2015a; 2015b; Cui et al., 2016) by
documenting the incentives for engaging in a greater quality policy of disclosure; i.e.
decreasing information asymmetries and then, the cost of capital. And, we also
contributes to the research about the benefits of financial disclosure with greater quality,
documenting that high quality of financial reporting leads to a positive economic
consequences reflected in lower information asymmetries (Bhattacharya et al., 2013)
and the cost of capital (Francis et al., 2005).
Methodologically, this paper also provides empirical insights to complement
theoretical models (e.g. Diamond & Verrecchia, 1991; Easley & O’Hara, 2004; Apergis
et al., 2011; Lambert et al., 2007 and 2011, among others), and other studies biased to
specific countries firms (e.g. in Australia, He et al., 2013; in Switzerland, Hail 2002, &
34
Petrova et al. 2012; in Canada, Richardson & Welker, 2001; in China, Hung et al.,
2013; for NYSE and NASDAQ firms, Bhattacharya et al., 2013), and/or activity sectors
(e.g. for manufacturing firms, Botosan, 1997; for non-financial firms, Hail, 2002, and
Petrova et al. 2012; El Ghoul et al., 2011 for tobacco and nuclear power industries). In
addition, since the sample companies operate in different countries, sensitivity checks
have been developed to control for differences in accounting standards and other
institutional factors, such as the level of investor protection. Finally, the use of panel
data enables us to control for year-on-year effects, and then, our findings are potentially
more powerful and generalizable.
Beyond these theoretical implications, our study also has several practical
implications. Concretely, empirical findings suggest that companies may influence their
cost of capital by affecting the information availability in market, both about financial
and non-financial aspects. These findings are special relevant for managers,
shareholders and policy-makers. Managers may see corporate disclosures as incentive to
minimize information asymmetries, avoiding costs of adverse selection and then,
decreasing the cost of equity. Thus, managers should consider the quality of disclosure
in determining the optimal strategy of reporting (reducing risk estimation, returns stock
volatility, increasing long term shareholder value and reputation of the firm). Moreover,
managers are encouraged to undertake disclosure policies of greater quality for
obtaining personal benefits, such as continuity in their jobs and increase of their
personal reputation as managers.
In addition, our evidence suggests that policy disclosure does not relate only to
the information required by law, but also to company-specific factors; that is, those that
determine the voluntary disclosure decision about CSR. Our results suggest to
companies give higher priority to the development of appropriate and complete policies
35
about disclosure. Thus, one implication of our results is that companies should not be
concern about their possible influence on analysts to improve the credibility of your
information, but they must be who determine their strategy to influence on the
information available to capital market, affecting the estimation risk component and
then, in the cost of capital.
Additional practical implication of this study concerns the conclusions that
should be drawn by shareholders and other stakeholders in companies directly affected
by the disclosure policies, both about financial and non-financial information. Our
evidence could be useful for investors in evaluating the information provided by firms
in their disclosure policies, and more concretely, the quality of this information. Our
findings suggest that uninformed investors can require compensation for participating in
a market with other investors more informed. But, the quality of corporate information
reported may solve this price compensation. By reporting financial and social
information of greater quality, companies can decrease the return demanded by
investors whereas all have the same information availability. Moreover, investors
should be aware of the use of disclosure policies to enhance credibility and confidence
about financial and sustainability information as a signal for future investment
decisions. In any case, quality of disclosure may add value for shareholders and
stakeholders by showing the managerial commitment to reporting credible financial and
sustainability information.
Our findings may be also interesting for policy markets and regulatory
organisms, given understanding the benefits of a greater quality of financial and non-
financial disclosures. For example, they could collaborate with companies in the
promotion of institutional support programmes to ensure the quality of information
reported. Thus, as policy implication, our evidence suggests that the different
36
information availability between informed and uninformed investors that influences the
return rate of their investments can be solved through a good disclosure strategy.
Public authorities should provide new national laws and requirements,
legislative reforms, institutional programmes or financial support in influencing
increased the quality of information reported, which adds value to organizations without
costly regulation. Financial information is legislative regulated, but in general, social
and environmental disclosure is unregulated and non-standardized given the absence of
regulatory laws and the lack of any standards for reporting. Our findings suggest that
social reporting quality is also valuated by investors in taking their investment
decisions, and greater quality may reduce information asymmetries and the cost of
capital. Moreover, the combined work of national governments seems necessary for
achieving improvements in non-financial disclosures, for instance the development of a
regulatory law and/or a generalized standard at the international level.
The main limitation to our study is the impossibility of running sensitive
analyses based on different empirical proxies of information asymmetry and the cost of
capital, because we did not have access to more data than that used in this paper. In
view of the controversy surrounding the validity of several proxies for capturing
information asymmetry and cost of capital and given the lack of data availability, future
research should validate the results obtained here with alternative measures. For
example, representing information asymmetries by the bid–ask spreads or share price
volatility; and by employing the Claus and Thomas model (2001) or the Ohlson and
Juettner-Nauroth model (2005) as alternative models of the cost of equity. Moreover, it
is important to recognize our disclosures measures reflect the completeness and
informativeness of financial and social disclosures but they do not indicate whether the
information reflects “good” or “bad” news.
37
On the other hand, although it is one of the remarkable contributions of the
study, the use of an international database generates divergence of information –
especially considering different legal environments or institutional variations. Due to
the limited information available in the different databases, the sample is restricted to
specific countries biased, at least in part, to US, UK and Japanese firms. Future research
must increase the sample of analysis to additional countries and, even more,
institutional and legal aspects should be addressed. It would be interesting to examine
not only the accounting standard employed or the level of country´s investor protection,
but also the corporate governance systems, the level of country´s stakeholder
orientation, in what extent the Hofstede´s cultural dimensions affects to our findings,
the market capital legislation, and so on.
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Table 1. Sample distribution
Panel A. Distribution by year and country
2007 2008 2009 2010 2011 2012 2013 2014 Total
Belgium 0 0 0 0 11 12 12 12 47
Canada 62 73 74 75 74 74 74 71 577
Denmark 0 11 11 10 15 15 15 15 92
Finland 0 18 18 18 23 23 23 23 146
France 0 27 27 28 30 31 30 29 202
Germany 25 35 36 40 48 48 48 45 325
Hong Kong 0 0 0 0 8 8 8 8 32
India 0 0 0 0 67 67 68 69 271
Italy 107 112 103 100 72 74 69 63 700

Japan 0 0 0 0 73 75 77 77 302
Netherland 55 55 30 31 31 32 31 31 296
Norway 0 15 15 15 18 18 18 18 117
Spain 56 58 58 58 65 69 67 60 491
Sweden 0 10 13 19 17 17 18 18 112
Switzerland 0 0 0 1 12 13 13 12 51
UK 91 104 110 110 110 107 104 96 832
USA 311 341 370 385 389 391 392 360 2,939
Panel B. Distribution by year and activity sectors
2007 2008 2009 2010 2011 2012 2013 2014 Total
Basic Materials 28 36 39 40 52 52 51 47 345
Industrial 342 408 404 419 514 520 520 498 3,625
Utilities 50 59 68 69 83 83 81 78 571
Services industry 68 87 87 89 103 103 100 92 729
Construction 29 35 31 31 37 36 36 33 268
Retail 73 90 89 91 110 115 116 104 788
Transportation 25 29 28 29 37 36 36 35 255
Telecommunications 69 87 92 94 99 100 98 91 730
Others 23 28 27 28 28 29 29 29 221
Total 707 859 865 890 1,063 1,074 1,067 1,007 7,532
49
Table 2. Categories of SRQ variable
SRQ values Type of CSR report
GRI = 0 Companies that do not disclose CSR information
GRI= 25 Companies that disclose CSR information which does not comply with
GRI guidelines.
Companies that disclose CSR information following the C level of the

GRI guidelines, i.e. their reports are very basic. More specifically, the
report incorporates information on:
Profile Disclosures: statement numbers 1.1; 2.1–2.10; 3.1–3.8; 3.10–
3.12; 4.1–4.4; 4.14–4.15 (see GRI guidelines version 3).
Disclosures on management approach: not required.
GRI = 50 Performance indicators and sector supplement performance
indicators: a minimum of any 10 performance indicators, including at
least one from each of the social, economic and environment
categories. Performance indicators may be selected from any finalized
Sector Supplement, but 7 of the 10 must be from the original GRI

guidelines.
Companies that disclose CSR information following the B level of the

GRI guidelines, i.e. their reports are complete. Specifically, the report
contains information on:
Profile Disclosures: statement numbers 1.1; 1.2; 2.1–2.10; 3.1–3.13;
4.1–4.17 (see GRI guidelines version 3).
Disclosures on management approach: for each indicator category.
GRI = 75 Performance indicators and sector supplement performance
indicators: a minimum of any 20 performance indicators, including at
least one from each of the economic, environment, human rights,
labour, society and product responsibility categories. Performance
indicators may be selected from any finalized Sector Supplement, but
14 of the 20 must be from the original GRI guidelines.
Companies that disclose CSR information following the A level of the

GRI guidelines, i.e. their reports are very advanced. More specifically,
the report incorporates information on:
GRI = 100 Profile Disclosures: 1.1; 1.2; 2.1–2.10; 3.1–3.13; 4.1–4.17 (see GRI
guidelines version 3).
Disclosures on management approach: for each indicator category.
Performance indicators and sector supplement performance
indicators: incorporates each core and sector supplement indicator.
Source: the authors, based on García-Sánchez, et al. (2014)
50
Table 3. SRQ scores distribution
Panel A. SRQ scores by country in percentage
SRQ Score
Country 0 10 25 50 100
Belgium 51.06% 38.30% 4.26% 4.26% 2.13%
Canada 61.53% 17.68% 8.49% 2.60% 9.71%
Denmark 63.04% 16.30% 7.61% 0.00% 13.04%
Finland 34.25% 10.96% 17.12% 15.75% 21.92%
France 54.46% 22.28% 4.95% 3.96% 14.36%
Germany 56.31% 13.85% 8.62% 9.85% 11.38%
Hong Kong 40.63% 21.88% 21.88% 0.00% 15.63%
India 45.39% 36.53% 13.28% 0.00% 4.80%
Italy 73.71% 15.29% 3.71% 1.71% 5.57%
Japan 55.63% 27.81% 5.63% 0.33% 10.60%
Netherland 76.35% 17.91% 2.70% 0.00% 3.04%

Norway 73.50% 26.50% 0.00% 0.00% 0.00%
Spain 63.34% 15.89% 7.94% 1.22% 11.61%
Sweden 48.21% 23.21% 9.82% 7.14% 11.61%
Switzerland 62.75% 19.61% 3.92% 0.00% 13.73%
UK 62.02% 17.91% 9.74% 5.05% 5.29%
USA 70.30% 16.84% 4.39% 2.79% 5.68%
Panel B. SRQ scores by activity sectors in percentage
SRQ Score
Activity Sector 0 10 25 50 100
Basic Materials 51.59% 19.13% 12.75% 2.61% 13.91%
Industrial 64.33% 18.54% 5.85% 3.56% 7.72%
Utilities 56.22% 18.04% 9.63% 4.90% 11.21%
Services industry 76.41% 11.11% 6.45% 2.06% 3.98%
Construction 59.70% 19.78% 7.46% 3.36% 9.70%
Retail 76.27% 17.13% 2.16% 1.52% 2.92%
Transportation 58.43% 17.25% 9.41% 5.49% 9.41%
Telecommunications 60.14% 24.25% 6.85% 1.64% 7.12%
Others 69.68% 22.17% 3.62% 1.36% 3.17%
Panel C. SRQ scores sample observations
SRQ Score
0 10 25 50 100
Freq. 4,891 138 477 231 553
Percentage (%) 64.94 18.32 6.33 3.07 7.34
Cumulating (%) 64.94 83.26 89.59 92.66 100
51
Table 4. Descriptive statistics and bivariate correlations

Descriptive statistics Bivariate correlations
Mean Std. Dev. 1 2 3 4 5 6 7 8
1. FRQ 8.0661 24.6576 1
2. SRQ 12.7671 27.4458 0.0371 1
3. rPEG 0.0813 0.0715 -0.0486† -0.0385* 1
4. IA 0.0427 0.7706 -0.0656** -0.0078 0.1787*** 1
5. Size 15.8104 1.5181 0.0084† 0.191*** -0.0827*** -0.0269† 1
6. Leverage 2.1945 3.4747 0.0458* 0.0003† -0.1062*** 0.0055 0.1039*** 1
7. MTB 0.0032 0.0064 -0.0119 -0.0319* -0.0131 -0.0139 -0.1169*** 0.4101*** 1
8. Dispersion 47.9430 21.4384 -0.0547* -0.009 -0.029 -0.0272† 0.0767*** 0.0059 0.0168 1
Sample: 1,260 firms in the period 2007-2014. The sample is unbalanced because companies are not in all periods, resulting in 7,542 observations.
FRQ represents the financial reporting quality, calculated by using the accruals quality model proposed by Ball and Shivakumar (2006); SRQ represents the social reporting
quality, and it takes values 0, 25, 50, 75, and 100 according to harmonization of CSR report in relation to the GRI guidelines; rPEG is the Price-Earnings-Growth ratio to
measure the cost of capital based on the model proposed Ohlson and Juettner-Nauroth (2003), and operationalized by Easton (2004); IA is the proxy of information
asymmetry calculated by the analysts’ forecast accuracy; Size represents the firm size calculated as the natural logarithm of total assets; Leverage is measured by the ratio of
total debt to total equity; Growth represents the firm’s growth opportunities calculated as the market-to-book ratio; and Dispersion is the dispersion of analyst forecasts,
defined as the coefficient of variation of 1-year-ahead analyst forecasts of earnings per share.
†, *, **, *** represent statistically significance at 90%, 95%, 99% and 99.9%, respectively.
52
Table 5. Empirical results from models 6 to 9

Dependent variable: IA Dependent variable: rPEG
Model 6 Model 7 Model 8 Model 9
Coef. Std. Err. Coef. Std. Err. Coef. Std. Err. Coef. Std. Err.
FRQ -0.0500*** 0.0049 -0.0160*** 0.0023 -0.004*** 0.0009
SRQ -0.0016* 0.0008 -0.0037*** 0.0009 -0.0029*** 0.001
IA 0.1119*** 0.0203 0.1909*** 0.0080
Size -0.0117 0.0080 -0.0467*** 0.0115 -0.0350*** 0.0103 -0.0564*** 0.0067
Leverage 0.0056*** 0.0011 0.0035*** 0.0003 0.0070*** 0.0009 0.0049*** 0.0007
Growth -2.7928*** 0.7707 -2.1211*** 0.3822 -4.3494*** 0.5340 -2.9394*** 0.3115
Dispersion 0.01345*** 0.0041 0.07183** 0.0272 0.0484* 0.0181 0.0062† 0.0034
Country Controlled Controlled Controlled Controlled
Industry Controlled Controlled Controlled Controlled
Year Controlled Controlled Controlled Controlled
Arellano-Bond test for
Pr > z = 0.389 Pr > z = 0.098 Pr > z = 0.21 Pr > z = 0.24
AR(2) in first differences
Hansen test of
Prob > chi2 = 0.262 Prob > chi2 = 0.835 Prob > chi2 = 0.391 Prob > chi2 = 0.88
overid. restrictions
HH <
%& = α + α efg
+ α hfg
+ αH Size + α< Leverage + α; Growth + αO Dispersion + ∑< T α Country + ∑n; βn Industryn + ∑H< β Year + u [6]
H <
6789 = θ + θ %& + θ Size + θH Leverage + θ< Growth + θ; Dispersion + ∑H
O θ Country + ∑n< βn Industryn + ∑HH β Year + e [7]

HH <
6789 = β + β efg
+ β hfg
+ βH Size + β< Leverage + β; Growth + βO Dispersion + ∑< T β Country + ∑n; βn Industryn + ∑H< β Year + ε [8]
H< <
6789 = λ + λ efg
+ λ hfg
+ λH %& + λ< Size + λ; Leverage + λO Growth + λT Dispersion + ∑;q λ Country + ∑nO λn Industryn + ∑H; λ Year + ϵ [9]

rPEG is the Price-Earnings-Growth ratio to measure the cost of capital based on the model proposed Ohlson and Juettner-Nauroth (2003), and operationalized by Easton (2004); IA is
the proxy of information asymmetry calculated by the analysts’ forecast accuracy; FRQ represents the financial reporting quality, calculated by using the accruals quality model
proposed by Ball and Shivakumar (2006); SRQ represents the social reporting quality, and it takes values 0, 25, 50, 75, and 100 according to harmonization of CSR report in relation
to the GRI guidelines; Size represents the firm size calculated as the natural logarithm of total assets; Leverage is measured by the ratio of total debt to total equity; Growth
represents the firm’s growth opportunities calculated as the market-to-book ratio; and Dispersion is the dispersion of analyst forecasts, defined as the coefficient of variation of 1-
year-ahead analyst forecasts of earnings per share; Countryj are j dummy variables that represent the different j countries of the sample – i.e. Belgium, Canada, Denmark, Finland,
France, Germany, Hong-Kong, India, Italy, Japan, Netherland, Norway, Spain, Sweden, Switzerland, the UK, and the USA; Industryk are k dummy variables that represent the
different k activity sectors in which the companies of the sample operate – i.e. basic materials, industrial, utilities, services industry, construction, retail, transportation, and
telecommunications, others; and Yeart are t dummy variables that represent the t years of the sample, from 2007 to 2014.
53
Arellano-Bond test for AR(2) in first differences is the test for second-order serial correlation in the first-differenced residuals, asymptotically distributed as N(0,1) under H0 no serial
correlation of the error terms; Hansen test of over-identification restrictions is the test for the validity of the over-identifying restrictions for the GMM estimator, asymptotically
distributed as chi2, under H0 the over-identifying restrictions are valid.
54
Table 6. Empirical results from models 6 to 9 including firms that apply IFRS only
FRQ -0.0375*** 0.0084 -0.0815* 0.0423 -0.0078*** 0.0018
SRQ -0.0015† 0.0007 -0.0130*** 0.0021 -0.0027*** 0.0007
IA 0.4496*** 0.0088 0.5162*** 0.0160
Size -0.0153† 0.0079 -0.0332*** 0.0012 -0.0348*** 0.0044 -0.0091** 0.0026
Leverage 0.0058*** 0.0011 0.0037*** 0.0001 0.0104*** 0.0006 0.0036*** 0.0005
Growth -2.9804*** 0.7452 -3.6078*** 0.0796 -9.2917*** 0.5284 -3.9818*** 0.5235
Dispersion 0.01414*** 0.0043 0.0816*** 0.0215 0.01759*** 0.00158 0.0226*** 0.00249
Pr > z = 0.439 Pr > z = 0.311 Pr > z = 0.99 Pr > z = 0.3
Hansen test of
Sample: 556 firms in the period 2007-2014. The sample is unbalanced because companies are not in all periods, resulting in 3,969 observations.
HH <
%& = α + α efg
+ α hfg
+ αH Size + α< Leverage + α; Growth + αO Dispersion + ∑< T α Country + ∑n; βn Industryn + ∑H< β Year + u [6]
H H <
6789 = θ + θ %& + θ Size + θH Leverage + θ< Growth + θ; Dispersion + ∑O θ Country + ∑n< βn Industryn + ∑HH β Year + e [7]

HH <
6789 = β + β efg
+ β hfg
+ βH Size + β< Leverage + β; Growth + βO Dispersion + ∑< T β Country + ∑n; βn Industryn + ∑H< β Year + ε [8]
; H<
6789 = λ + λ efg
+ λ hfg
+ λH %& + λ< Size + λ; Leverage + λO Growth + λT Dispersion + ∑q λ Country + ∑nO λn Industryn + ∑< H; λ Year + ϵ [9]

to the GRI guidelines; Size represents the firm size calculated as the natural logarithm of total assets; Leverage is measured by the ratio of total debt to total equity; Growth
represents the firm’s growth opportunities calculated as the market-to-book ratio; and Dispersion is the dispersion of analyst forecasts, defined as the coefficient of variation of 1-
year-ahead analyst forecasts of earnings per share; Industryk are k dummy variables that represent the different k activity sectors in which the companies of the sample operate – i.e.
basic materials, industrial, utilities, services industry, construction, retail, transportation, and telecommunications, others; and Yeart are t dummy variables that represent the t years
of the sample, from 2007 to 2014.
55
56
Table 7. Empirical results from models 6 to 9 controlling for investor protection influence
FRQ -0.0162*** 0.0028 -0.0352** 0.0127 -0.0084*** 0.0161
SRQ -0.0035* 0.0015 -0.0146* 0.0072 -0.0060*** 0.0108
IA 0.3368* 0.1635 0.5093*** 0.0301
FRQ_IP -0.0407*** 0.0050 -0.0230† 0.0128 -0.0095*** 0.0157
SRQ_IP -0.0082*** 0.0015 -0.0137† 0.0072 -0.0055*** 0.0107
IA_IP -0.0121 0.1630 0.0263*** 0.0074
IP -0.0613*** 0.0054 -0.0706*** 0.0079 -0.0557* 0.0278 -0.2181*** 0.0392
Size -0.0094* 0.0039 -0.0001 0.0027 -0.0070* 0.0027 -0.0382*** 0.0034
Leverage 0.0185*** 0.0012 0.0032*** 0.0000 0.0082*** 0.0004 0.0048*** 0.0006
Growth -13.5307*** 0.9241 -0.4552*** 0.0115 -7.6077*** 0.4209 -4.6518*** 0.3867
Dispersion 0.0363† 0.0208 0.0005*** 0.0001 0.0116*** 0.00084 0.0006*** 0.0001
Pr > z = 0.523 Pr > z = 0.09 Pr > z = 0.151 Pr > z = 0.333
Hansen test of
to the GRI guidelines; IP represents the level of investor protection according to La Porta et al. (1998), and it is interacted with IA, FRQ, and SRQ; Size represents the firm size
calculated as the natural logarithm of total assets; Leverage is measured by the ratio of total debt to total equity; Growth represents the firm’s growth opportunities calculated as the
market-to-book ratio; and Dispersion is the dispersion of analyst forecasts, defined as the coefficient of variation of 1-year-ahead analyst forecasts of earnings per share; Industryk
are k dummy variables that represent the different k activity sectors in which the companies of the sample operate – i.e. basic materials, industrial, utilities, services industry,
construction, retail, transportation, and telecommunications, others; and Yeart are t dummy variables that represent the t years of the sample, from 2007 to 2014.
57
Figure 1
Relations between corporate disclosures, information asymmetry and cost of capital
58
ANNEX 1
Table A1.
Validation of financial and social disclosures proxies
Model 10 Model 11
FRQ SRQ
Coef. Std. Err. Coef. Std. Err.
Size 6.5163** 2.0504 0.4199*** 0.0525
Profitability 0.0927* 0.0400 0.0095* 0.0048
Leverage 0.8097*** 0.2050 0.0218* 0.0098
Countryj Controlled Controlled
Industryk Controlled Controlled
Yeart Controlled Controlled

Arellano-Bond test for AR(2): Cut1: 3.5051***
Pr > z = 0.35 Cut2: 4.5323***
Cut3: 5.0209***
Hansen test : Cut4: 5.3264***
Pr > χ2 = 0.788 Rho: 0.6733***
Sample: 1,260 firms in the period 2007-2014. The sample is unbalanced because companies are not in all
periods, resulting in 7,542 observations.
FRQ = γ + γ Size + γ Profitability + γH Leverage + ∑

< γ Country + ∑n γn Industryn +
H
∑<
HH γ Year + ϵ [10]
SRQ = γ + γ Size + γ Profitability + γH Leverage + ∑
< γ Country + ∑n γn Industryn +
H
∑<
HH γ Year + ϵ [11]
FRQ represents the financial reporting quality, calculated by using the accruals quality model proposed
by Ball and Shivakumar (2006); SRQ represents the social reporting quality, and it takes values 0, 25, 50,
75, and 100 according to harmonization of CSR report in relation to the GRI guidelines; Size represents
the firm size calculated as the natural logarithm of total assets; Profitability is represented by the return
on assets ratio – ROA; Leverage is measured by the ratio of total debt to total equity; Countryj are j
dummy variables that represent the different j countries of the sample – i.e. Belgium, Canada, Denmark,
Finland, France, Germany, Hong-Kong, India, Italy, Japan, Netherland, Norway, Spain, Sweden,
Switzerland, the UK, and the USA; Industryk are k dummy variables that represent the different k
activity sectors in which the companies of the sample operate – i.e. basic materials, industrial, utilities,
services industry, construction, retail, transportation, and telecommunications, others; and Yeart are t
dummy variables that represent the t years of the sample, from 2007 to 2014.
Arellano-Bond test for AR(2) in first differences is the test for second-order serial correlation in the first-
differenced residuals, asymptotically distributed as N(0,1) under H0 no serial correlation of the error
terms; Hansen test of over-identification restrictions is the test for the validity of the over-identifying
restrictions for the GMM estimator, asymptotically distributed as chi2, under H0 the over-identifying
restrictions are valid.
59

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Management Decision

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Cost of capital, information asymmetry, and corporate disclosures are topics

information asymmetry among investors creates trading frictions by introducing adverse

return for investing in firms with wide information asymmetries.

A number of studies have suggested that corporate disclosures tend to reduce

the cost of capital will be reduced thanks to a reduction of information asymmetries

derived from larger corporate disclosures. Nevertheless, this conclusion is extrapolated

words, information asymmetry could be seen as a mediator in the relationship between

independent models, by using different samples, methodologies, and different proxy

decreasing information asymmetries by corporate disclosures on the cost of capital in an

international setting. In addition, we focused on both financial and social disclosures

has been evidenced (Richardson & Welker, 2001).

highlighting the role of information asymmetry as a mediator component. Specifically,

we empirically test three links: (i) corporate disclosure quality – information

resulting in 7,542 observations. The firms are from different countries—Belgium,

transportation, and telecommunications.

The remainder of this paper is organized as follows: In the next section, we

finally, we conclude with some remarks.

Theoretical background: Literature review and research propositions

Corporate disclosures play a fundamental role in the functioning of an efficient

quality is highly appreciated by investors, because if it is not readily available, well

perceived in the market to have a lower likelihood of withholding relevant unfavorable

empirically tested the effectiveness of voluntary disclosures in obtaining financing

market portfolio decrease, which in turn reduces the cost of capital.

Focused on financial and accounting information, Lambert et al. (2007) noted

difference between observable accounting earnings and unobservable economic

accounting disclosure quality, leads to a decrease in the cost of capital.

Another line of research is focused on how corporate disclosures affect

information asymmetries. Information asymmetries arise from differences in

between non-financial disclosures and information asymmetry, in terms of the bid–ask

by the decreasing of the adverse selection problem faced by less-informed investors.

and cost of equity.

(quality) affect the cost of capital by decreasing information asymmetry. More

Commission, indicated the quality of accounting standards is positively linked to

Lambert et al. (2011) developed a theoretical model to explain how information

amount of information that is reflected in prices, which in turn reduces investors’

increases with a higher level of information asymmetry, by using a sample of firms

(Diamond & Verrecchia, 1991).

From the above, previous studies have individually reported a relationship

between information asymmetries, corporate disclosures, and the cost of capital. A

seen as a mediated link – i.e. information asymmetry is determined by the degree of

could be considered as a mediator, whose role is analyzed in this study.

Theoretical research propositions

where r is a proxy of the cost of capital, y represents disclosures, and X is a

forecast dispersion and long-term growth forecast, among others.

new component, z, on the functional relation [1]:

where z represents the level of information asymmetries. Our paper introduces

expect that information asymmetries act as a mediator between corporate disclosures

and cost of capital, such as is represented in Figure 1.

<Insert Figure 1 here>

Relation 1 represented in Figure 1 is focused on the link between corporate

disclosure and information asymmetry, which could be statistically represented by

dispersion, whose effects on information asymmetry have been extensively tested by

the level of disclosures (y

interested in α that is the change in information asymmetry under variations in

In this respect, several authors have found a negative association between

relation between asymmetries and disclosures:

Relation 2 of Figure 1, i.e. how information asymmetry is associated with the

cost of capital, could be statistically represented by equation [4]:

r = θ + θ z + ∑  θ x + e

information asymmetries of firm i in year t; xj represents the j control variables, such as

control variables (x ). θ is the change in the cost of capital under variations of

interested in α that is the change in information asymmetry under variations in

r = θ + θ z + ∑ θ x + e

control variables (x ). θ is the change in the cost of capital under variations of

r = θ + θ (α + α y

r = (θ + θ α ) + θ α y

In equation [5] the constant term is β = θ + θ α , the relationship between

asymmetries on cost of capital, and α , which is the effect of disclosures on

Verrecchia (2000), among others, we expect