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Business Fin Account - 2014 - Blanco - Segment Disclosure and Cost of Capital
Business Fin Account - 2014 - Blanco - Segment Disclosure and Cost of Capital
Journal of Business Finance & Accounting, 42(3) & (4), 367–411, April/May 2015, 0306-686X
doi: 10.1111/jbfa.12106
1. INTRODUCTION
There is an ongoing debate as to whether and how accounting quality decreases
the cost of capital. One stream of the literature suggests that accounting quality
reduces information asymmetries, which, in turn, decreases the cost of capital (Easley
and O’Hara, 2004). More recently, several studies demonstrate that information
differences across investors affect a firm’s cost of capital through information precision
(Hughes et al., 2007; Lambert et al., 2007, 2012). Standard setters (SFAS 131) and
practitioners (e.g., Ernst and Young, 2004) hold the view that segment reporting is
key to improving information precision, permitting a better evaluation of firm future
∗ The first author is from the University of Melbourne. The second and third authors are from the Univer-
sidad Carlos III de Madrid. We appreciate the comments and suggestions contributed by an anonymous
reviewer, Peter Pope (the editor), Alicia Barroso, Daniel Cohen, Beatriz Garcia Osma, Joachim Gassen,
Miles Gietzmann, Javier Gil Bazo, Begoña Giner, Paul Healy, Araceli Mora, Per Olsson, Fernando Peñalva,
Rosa Rodriguez, David Smith, Jeroen Suijs, Laurence Van Lent, Steve Young and seminar participants at
the 2014 JBFA Capital Markets Conference, 2010 AAA Financial Accounting and Reporting Section Mid-
Year Meeting, the 2009 American Accounting Association annual meeting, the 2009 annual congress of the
European Accounting Association, the 2009 European Accounting Association Doctoral Colloquium, the
V Symposium for accounting academics (2009, Leeds Business School), the VII Workshop on Empirical
Research in Financial Accounting (2010, Universidad Politécnica de Cartagena), Universidad Carlos III
de Madrid, Universidad de Valencia, Universidad de Navarra, Universitat Pompeu Fabra de Barcelona,
Universitat Autònoma de Barcelona, Tilburg University, The University of Melbourne and IE University. We
acknowledge financial assistance from the Spanish Ministry of Economy and Competitiveness (ECO2013–
48328-C3–3-P, ECO2010–19314, ECO2009–10796 and, ECO2012–36559), the European Commission IN-
TACCT Research Training Network (MRTN-CT-2006–035850), the Fundación Ramón Areces, and the
government of the Autonomous Community of Madrid (Grant # 2008/00037/001).
Address for correspondence: Belen Blanco, University of Melbourne, Department of Accounting, Level 7,
198 Berkeley Street, Building 110, Carlton 3010, VIC, Australia. E-mail: belen.blanco@unimelb.edu.au.
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368 BLANCO, GARCIA LARA AND TRIBO
prospects. These views of regulators and practitioners are also supported by prior
research, as there is plenty of evidence that a commitment to provide comprehen-
sive segment disclosure leads to a rich information environment characterized by:
(1) better predictive ability and increased precision of accounting numbers (e.g.,
Kinney, 1971; Collins, 1976; Silhan, 1983; Baldwin, 1984; Balakrishnan et al., 1990;
Swaminathan, 1991; Berger and Hann, 2003; and Ettredge et al., 2005), (2) reduced
information asymmetries (Greenstein and Sami, 1994), and (3) improved monitoring
ability over managerial decision making (Bens and Monahan, 2004; Berger and Hann,
2007; and Hope and Thomas, 2008). All of these effects of segment disclosure are
expected to make capital markets more efficient (Collins, 1975) and to facilitate firms
the access to external financing (Ettredge et al., 2006).1
However, the effect of segment information on cost of capital is not obvious. While
segment information improves the information environment, decreasing estimation
risk, it is likely that it also favors competitors, creating uncertainties about future
earnings and cash flows (Hayes and Lundholm, 1996; Stanford Harris, 1998). For
example, Bugeja et al. (2015) find evidence consistent with firms being reluctant to
provide segment information whenever most of their segments are profitable. Several
studies provide evidence consistent with increased competition leading to increased
uncertainty about future profitability that in turn leads to increases in the costs of
financing (Gaspar and Massa, 2006; Valta, 2012). Given these two expected opposite
effects of improved segment disclosure on cost of capital, we expect that the benefits
of segment disclosure, in terms of lower cost of capital, will be less pronounced and
might even disappear for firms subject to tougher competition.
To test our main hypothesis, that is, that segment disclosure leads to lower cost
of capital and that this effect is bound to be less pronounced or even disappear for
firms subject to competitive pressures, we construct a proxy for voluntary segment
disclosures based on the counting of the number of items of segment reporting
disclosed on a voluntary basis. In our proxy for voluntary segment disclosures we
control, following Clinch and Verrecchia (2013), for exogenous factors that affect
segment disclosure and also cost of equity capital. In particular, we take the residual
of a specification explaining the number of voluntarily disclosed items in terms of
these exogenous factors. That is, our segment disclosure score captures whether the
firm discloses more or less than what one would predict given its characteristics
(diversification, different types of risks, growth, etc.). We posit that firms that disclose
more than analysts expect ex-ante given their characteristics will be rewarded with
a lower cost of capital. This approach of using the residual of an estimation of
the number of voluntarily disclosed items on the determinants of the disclosure
decision tackles endogeneity issues related to spurious correlations among common
determinants of the cost of capital and voluntary disclosure. For example, Hann
et al. (2006) show that more diversified firms have a lower cost of capital. Given
that diversified firms will provide more segment disclosures, it is crucial that in our
segment disclosure proxy we control for diversification. Similarly, Gietzmann and
Ostaszewski (2014) show that firms for which estimating future earnings is more
difficult, which arguably will affect the cost of capital, disclose more. Our segment
1 Most prior literature assumes that increased disclosure increases the overall amount of information
available in the economy. However, in an analytical study, Tang (2014) shows that increased disclosure could
also discourage private information production and might also lead to a decreased amount of information
overall. While theoretically sound, prior empirical evidence does not support this argument.
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SEGMENT DISCLOSURE AND COST OF CAPITAL 369
disclosure proxy also controls for the determinants of the difficulty in estimating
future earnings. Also, from the findings in Johnstone (2013), one could argue that
improved disclosure could lead to higher cost of capital because of the unveiling of
certain operational or financial risks. Again, we define our segment disclosure score
to control for different types of risk. Once we control for the previous variables in
the construction of our proxy for voluntary disclosure, we expect, first, the score
generated to be a sticky variable that captures a pre-specified disclosure policy.2 Firms
with a higher score are firms for which estimating future profitability measures (like
earnings or cash flows) is easier. Second, our segment disclosure score controls for
the main determinants of the decision to disclose segment information: business and
geographic diversification, information asymmetries, operating risk, growth options,
performance, etc. Therefore, our results capture information effects of segment
disclosure, and not any of the effects that the aforementioned variables could have
on the cost of capital that may generate endogeneity problems of spurious correlation
between cost of capital and voluntary segment disclosure.
Using a sample of non-regulated and non-financial firms for the period 2001–2006,
and our proxy for voluntary segment disclosure, we show that firms providing better
segment disclosure enjoy lower costs of equity capital. We find, however, that such
decrease in the cost of equity capital is less pronounced in the presence of larger
competitive pressures. These results are robust to the use of tests based on asset pricing
and implied cost of equity capital. In addition, we provide empirical evidence that
segment disclosure improves investors’ ability to estimate the firm’s future earnings
by showing that better segment disclosure reduces analysts’ forecast errors. Finally, we
show that the provision of better segment information leads to a reduction in the firm’s
covariance with other firms’ returns, which is also consistent with improved segment
disclosure reducing estimation risk.
In all of our tests we control for the effects of earnings (accruals) quality on cost
of capital. It is noteworthy that in the asset pricing tests we find that accruals quality
is not a priced factor. This finding is in line with the results reported by Core et al.
(2008). We do not interpret our results, though, as segment reporting being as or
more important than accruals quality. On the contrary, a more plausible explanation
is that segment disclosures arise from an attempt at improving financial reporting in
all of its dimensions.
We provide robust results that add to prior research on the links between voluntary
disclosure and cost of capital (Botosan, 1997; Botosan and Plumlee, 2002; Gietzmann
and Ireland, 2005; Francis et al., 2008; and Dhaliwal et al., 2011). These studies offer
mixed evidence on the impact of voluntary disclosure on cost of capital. These mixed
results could be, in part, explained by the types of voluntary disclosures studied in
these prior papers. Our study differs from this prior research in that we use a type of
disclosure, segment reporting, with a clear predictive ability over future earnings and
cash flows (i.e., Kinney, 1971; Collins, 1976; Silhan, 1983; Baldwin, 1984; Balakrishnan
et al., 1990; Swaminathan, 1991; Berger and Hann, 2003; and Ettredge et al., 2005),
while prior studies have either used very wide and aggregate proxies for disclosure
(like AIMR scores in Botosan and Plumlee, 2002) or relatively softer information
2 Prior research shows that firms commit to disclosure strategies and that there is little variation in
disclosure quality across time. In particular, Leung and Verriest (2015) show that firms do not alter their
geographic segment disclosures in response to the passage of IFRS 8, which reduced substantially the
required disclosures on geographic segments.
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370 BLANCO, GARCIA LARA AND TRIBO
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SEGMENT DISCLOSURE AND COST OF CAPITAL 371
3 Cheynel (2013) provides analytical evidence showing how voluntary disclosures reduce the cost of capital
of disclosing firms.
4 Prior research shows that improved segment disclosure leads to lower agency costs in the form of improved
investment decisions (Hope and Thomas, 2008; Blanco et al., 2014).
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H1: Firms that disclose better segment information are rewarded with a lower cost
of capital.
H2: Proprietary costs moderate the relation between segment disclosures and cost of
capital. The decrease in cost of capital driven by segment disclosure is expected
to be less pronounced (or even become an increase in cost of capital) for firms
that suffer larger competitive pressures.
3. RESEARCH DESIGN
5 There is a large stream of literature showing that competition decreases disclosure. For example, Burks
et al. (2013) analyze how banks’ disclosure policies are affected by increases in bank competition. There
is also evidence for non-financial firms on how product market competition affects disclosure (Board,
2009). More related to the effects of disclosure and proprietary costs on financing, Yosha (1995) shows that
there are financing consequences connected to the costs of disclosing private information to competitors.
Hence, competition affects disclosure policies given the higher proprietary costs of information disclosure
in competitive environments.
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SEGMENT DISCLOSURE AND COST OF CAPITAL 373
or a voluntary basis. Second, for the compulsory segments, we distinguish between the
items reported compulsorily, as required by SFAS 131, and the items reported on a
voluntary basis. Third, we create the business (geographic) segment score, Qtt Seg Bus
(Qtt Seg Geo), by adding 1 point for every voluntarily disclosed item in every mandatory
business (geographic) segment, and 1 point for every item in each voluntary business
(geographic) segment. Finally, we create the overall index of quantity of voluntary
segment disclosure (Qtt Seg) by summing the business and geographic segment scores.
In the Appendix we describe the criteria that we use to distinguish between mandatory
vs. voluntary segments, and mandatory vs. voluntary items.6
Once we have calculated the voluntary segment disclosure index (Qtt Seg), in
order to obtain the index for quality of segment disclosure (Qlt Seg) we estimate the
following industry fixed effect regression:
We take the decile ranks of the residuals of Model (1) and interpret firms in the
lowest decile (more negative residuals) as firms that provide less segment information
than expected given their characteristics (diversification, etc.) and, consequently,
these are firms for which the estimation of future cash flows becomes more difficult
than investors expected it to be. That is, firms in the lowest decile of the residuals
of Model (1) are expected to bear more estimation risk. On the other hand, firms
in the top decile disclose more segment information than expected given their
characteristics, and thus these are firms for which estimating future cash flows becomes
easier. That is, firms in the top decile of the residuals of Model (1) bear lower
estimation risk. For expositional purposes we refer to these decile ranks as segment
reporting quality (Qlt Seg).
The three main determinants of segment disclosure in Model (1) are business and
geographic diversification and information asymmetries.7 More diversified firms and
with larger information asymmetries will be penalized with a larger cost of capital if
they do not provide additional segment information to facilitate the estimation of
their future cash flows. We measure business diversification using the primary and
6 We have studied the convergent validity (internal consistency) and discriminant validity of this index. For
internal consistency we rely on Cronbach’s alpha (Saini and Herrmann, 2013), which has a value of 0.8071
for the index. This figure is above the threshold of 0.7 considered as acceptable. Regarding discriminant
validity, we have investigated whether the items that we consider reported on a voluntary basis show larger
correlations among them than with the items that we consider reported on a mandatory basis (see Appendix
1). The correlations found are significantly larger within the group of voluntary items than between this
group and the group of mandatory items (intra-group correlations are higher than inter-group ones).
Hence, our index satisfies the convergent and discriminant validity tests.
7 We take information asymmetries in t−1 to prevent potential endogeneity problems of reverse causality
given that disclosure has a direct impact on information asymmetries.
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secondary SIC codes that Compustat assigns to each firm. For every firm, we create
the business diversification score by assigning 1 point for every different 2-digit SIC
code assigned by Compustat to the firm as forming part of its primary or secondary
activities. We define our geographic diversification index as the number of different
countries where the firm has subsidiaries.8 For example: if a given company X has four
subsidiaries, one in Spain, one in Italy and two in Croatia, we assign to this company a
geographic diversification score of 3, as the company has subsidiaries in three different
countries. Finally, we include, as a proxy for information asymmetries, the bid-ask
spread.9
As controls in Model (1) we include:
(a) Firm Size (the natural logarithm of firm’s market value of equity), as Buzby
(1975), Diamond and Verrecchia (1991) and Leuz (2004) find that larger firms
disclose more.
(b) Growth (the logarithm of the firm’s book-to-market ratio), as in Nagar et al.
(2003). Growth is an important control as growing firms disclose more and
measures of cost of capital can be noisy and influenced by growth (Easton and
Monahan, 2005).
(c) Earnings Qlt, a proxy for earnings quality (the absolute value of discretionary
accruals calculated using the modified Jones model, as in Dechow et al. (1995),
multiplied by −1 so that it increases with earnings quality),10 as Francis et al.
(2008) show a positive relation between earnings quality and overall disclosure
levels.
(d) Leverage (the ratio of total debt to total assets), as Jensen and Meckling (1976)
argue that leveraged firms incur larger monitoring costs and firms are expected
to disclose more to decrease these costs.
(e) Audit Firm, a dummy variable taking the value of 1 if the auditor is a Big Four
audit firm and 0 otherwise, as Hope (2003) finds that large audit firms pressure
their clients for increased disclosure.
(f) Listing Status, a dummy variable taking the value of 1 if the firm is listed on
the New York Stock Exchange (NYSE) or NASDAQ and 0 otherwise, given that
Leuz and Verrecchia (2000) find a link between disclosure and the firm listing
status.
8 We use subsidiaries information from Osiris. We take into account subsidiaries with a minimum of 25
percent of control by the company under analysis.
|bid −as k |
9 Measured as: Sp r e ad j,t = (bid j,tj,t+as k j,tj,t)/2 , where: bidj,t is firm j’s annual mean of the monthly bid prices for
year t, and askj,t is firm j’s annual mean of the monthly ask prices for year t.
10 Given the discussion regarding the usefulness of earnings quality proxies (Dechow et al., 2010), we also
run Model (1) using as alternative proxies for earnings quality the absolute values of the residuals of the
Jones (1991), Dechow and Dichev (2002) and McNichols (2002) models, and also the standard deviation
of the residuals of the Jones, modified Jones, Dechow and Dichev and McNichols models, calculated at the
firm level using rolling windows of five years, as in Francis et al. (2008). Our main results and inferences
do not vary when we use these other earnings quality proxies. Results are also robust to the use of signed
measures of earnings management.
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SEGMENT DISCLOSURE AND COST OF CAPITAL 375
(g) Proprietary Costs, a proxy for industry concentration based on the Herfindahl
index,11 as there is plenty of evidence showing that proprietary costs affect
segment disclosure levels (Hayes and Lundholm, 1996; Stanford Harris, 1998;
Botosan and Stanford, 2005; and Bugeja et al., 2015).
(h) New Financing, a dummy variable taking the value of 1 if the firm raised new
capital funds or increased debt in a given year, and 0 otherwise, as Ettredge
et al. (2006) show that firms providing better segment disclosure are more likely
to access external funds with better conditions.
(i) Profitability (the percentile ranks of return on assets) is expected to affect firm’s
disclosure policy (Raffournier, 1995).
(j) Firm Age, measured as the difference between the current year and the first year
in which the firm appears in CRSP (Center for Research in Security Prices).
Lang (1991) and Chen et al. (2002) argue that younger firms are subject
to greater uncertainty and they can achieve greater benefits from additional
disclosure. On the other hand, age is taken as a proxy for reputation (Roberts
and Dowling, 2002), and firms with better reputation are expected to disclose
more to maintain such reputation (Armitage and Marston, 2008). Hence, the
expected relationship is ambiguous.
(ii) Testing the Relation between Cost of Equity Capital and Segment Disclosure
We use four different sets of tests to analyze the relation between cost of equity
capital and segment information. First, we study whether better segment information
facilitates predictions about the firm’s future performance. To do so, we analyze
whether it reduces analysts’ forecast errors. Second, we test whether better segment
information reduces the covariance of firm’s returns with the returns of all firms in
the same industry, which, in the Lambert et al. (2007) setting, leads to a reduction in
the cost of capital. Third, we study whether segment reporting is related to implied
cost of equity capital measures. Finally, we investigate whether market participants
price segment information quality. To do so, we use asset pricing tests as in Core
et al. (2008). We explain each of the four sets of tests next.
N
11 Herf j = i=1 (Si j /S j )2 , where Sij = firm i’s sales in industry j, as defined by the two-digit SIC code; Sj
= the sum of sales for all firms in industry j; N = the number of firms in industry j. Greater values of Herf
indicate larger levels of industry concentration.
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376 BLANCO, GARCIA LARA AND TRIBO
where Cov(rj , rsector ) is the mean of the covariance between the monthly returns of the
firm and the monthly returns of all other firms in the industry where the firm operates,
over a one-year period. The coefficient of interest in Equation (3) is β 1 . If high quality
segment information reduces the covariance of the firm’s returns with the returns of
the firms in the same industry, β 1 will be significantly negative.
As before, we include earnings quality as a control. Regarding the other control
variables, previous studies find that beta – closely connected to the explained variable
of specification (3) – decreases with firm size, industry concentration, age, listing
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SEGMENT DISCLOSURE AND COST OF CAPITAL 377
status and diversification (Subrahmanyam and Thomadakis, 1980; Caves, 1982; Kim
et al., 1989, 1993; Lubatkin and Rogers, 1989; Harvey, 1991; Fama and French, 1992,
1993; and De Andres et al., 2014), and increases with book-to-market, leverage and
profitability (Fama and French, 1992, 1993). We include all of these variables as
controls in Equation (3).
r E X −AN T E j,t = α + β1 Qlt Seg j,t + β2 Earnings Qlt j,t + β3 Size j,t
+ β4 BM j,t + β5 Beta j,t + β6 Leverage j,t
+ β7 Business Diversification j,t + β8 Geographic Diversification j,t
+ βk Control sector year k, j,t + ε j,t (4)
k
12 We do not use the Claus and Thomas (2001) measure as Hail and Leuz (2006) and Botosan et al. (2011)
show that it is highly correlated with the proxy based on the Ohlson and Juettner-Nauroth (2005) model. In
particular, Hail and Leuz (2006) report a correlation of 0.945 between the two.
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related to the use of implied cost of equity capital proxies based on analysts’ forecasts,
we also estimate Equation (4) using a different proxy for risk, returns volatility, as the
dependent variable.
Regarding the control variables in Equation (4), we include a proxy for earnings
quality, to be certain that our segment reporting proxy is not just capturing the
overall quality of earnings. Also, previous literature finds that increases in size lead
to a decrease in the cost of capital (Fama and French, 1992, 1993; and Hail and
Leuz, 2006). We measure size as the logarithm of market equity value. The market
perceives high-growth firms as riskier, consistent with the asset pricing theory. Thus, we
include the log of the book-to-market ratio (Fama and French, 1992, 1993; Gebhardt
et al., 2001; and Hail and Leuz, 2006). Also, the capital asset pricing model (CAPM)
suggests that market beta should be associated with the cost of equity. Given this,
we include beta, measured as the coefficient from firm-specific CAPM regressions of
the firm’s returns, using the 60 months preceding fiscal year t, and a value-weighted
NYSE/AMEX/NASDAQ return as market index return.13 Additionally, we include
leverage, as it drives cost of capital upwards (Modigliani and Miller, 1958; Fama and
French, 1992, 1993). Finally, we include firm’s diversification, as it is associated with
lower risk (Caves, 1982; Kim et al., 1989, 1993; Lubatkin and Rogers, 1989; and Harvey,
1991), and with lower ex-ante cost of capital proxies (Hann et al., 2006).
We include the excess market return (RMRF), size (SMB) and value versus growth
stocks (high minus low book-to-market, HML) as in Fama and French (1992, 1993).
We also include momentum portfolios (UMD) as in Carhart (1997), and liquidity
portfolios (LIQ) as in Liu and Du (2014).
In Model (5), α represents the average return in excess of the return predicted
by the portfolio sensitivity to the risk factors in the model. If the model is properly
13 It is important to note that by including beta in the specification, we are capturing incremental effects of
voluntary segment information beyond what is internalized in financial markets through the beta parameter.
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SEGMENT DISCLOSURE AND COST OF CAPITAL 379
specified (i.e., if it includes all risk factors that affect the firm), the estimated α should
be zero (Black et al., 1972). However, if the model omits a risk factor, then portfolios
with greater exposure to that factor will have higher α, because they have greater
average excess return unexplained. If segment information quality is a risk factor,
and it is orthogonal to beta, size, momentum, book-to-market and liquidity effects,
then we should observe decreasing estimates of α in Model (5) as we move from
bad to good segment information quality portfolios (long on firms providing the best
segment information quality and short on those with the worst segment information
quality).
As an additional set of tests, we investigate whether segment disclosure has an
influence on the firm’s realized returns. To do so, we create a HILO Qlt Seg factor.
This factor is the return of the value-weighted factor-mimicking portfolio for segment
disclosure.14 We rank Qlt Seg into quintiles and we take a long position on the two
quintiles with the best segment information and a short position on the two quintiles
with the worst segment information. As in previous tests, we control for Earnings Qlt. To
do so, we create a HILO Earnings Qlt factor, taking a long position on the two quintiles
with the best accrual quality and a short position on the two quintiles with the worst
accrual quality. We then use a two-stage cross-sectional regression approach, where
excess returns are regressed on risk factor betas.
In the first stage, we estimate multivariate betas from 25 value-weighted portfolios
sorted by Size and B/M15 using a time-series regression of excess returns for a portfolio
on the contemporaneous returns to the Fama–French, momentum and liquidity
factors, the segment disclosure quality factor and the earnings quality factor:
where Rp,t is the return of portfolio p for month t. RMRF is the excess return on the
value-weighted market portfolio. Excess returns equal the value-weighted return on
the value-weighted NYSE/AMEX market index return from CRSP less the risk-free
rate. SMB (Small minus Big) is the monthly return of small firms over big firms, and
HML (High minus Low) is the monthly return of high B/M firms over low B/M firms.
HILO Qlt Seg is the monthly return of good quality segment disclosure firms over poor
quality segment disclosure firms and HILO Earnings Qlt is the monthly return of good
earnings quality firms over poor earnings quality firms.
In the second stage, we collect the portfolio-specific loadings from Equation (6) and
estimate the factor premium conditional on the first-stage loadings with cross-sectional
regressions using the Fama and MacBeth (1973) procedure to mitigate concerns about
cross-sectional dependence in the data. The model is as follows:
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If firms providing better segment information enjoy a lower cost of capital, then δ 6
should be negative.
r E X −AN T E j,t = α + β1 Qlt Seg j,t + β2 Competition j,t + β3 Q lt Se g j,t × Competition j,t
+ β4 Earnings Qlt j,t + β5 Size j,t + β6 BM j,t + β7 Beta j,t
+ β8 Leverage j,t + β9 Business Diversification j,t
+ β10 Geographic Diversification j,t + βk Control sector year k, j,t + ε j,t (8)
k
16 This is defined as Industry Markup = (Value of Sales + Inventories − Pension & Retirement Expenses − Cost
of Materials)/(Value of Sales + Inventories). We employ pension and retirement expenses instead of payrolls
because of data availability in Compustat.
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SEGMENT DISCLOSURE AND COST OF CAPITAL 381
2014). Our sixth measure is Exist-Comp, the first principal component extracted from
principal component analysis of four competition variables: IND-HHI, IND-CON4,
IND-NUM and IND-MKTS, where IND-HHI is the negative of the Herfindahl index;
IND-CON4 is the negative of the four-firm concentration ratio, measured as the sum
of market shares of the four largest firms in an industry; IND-NUM is the total number
of firms in the industry; and IND-MKTS is the product market size, measured as the
natural log of industry aggregate sales. Li (2010) and Dhaliwal et al. (2014) use this
measure as a proxy for existing competition, and provide a thorough discussion of why
they consider these four components, and not others.
Finally, our last measure is the Speed of Profit Adjustment (SPA) metric (Stanford
Harris, 1998). To estimate SPA we run the following regression separately for each
three-digit SIC and year:
Xi, j,t = β0, j + β1, j (Dn Xi, j,t−1 ) + β2 j (Dp Xi, j,t−1 ) + εi, j,t (9)
where Xi,j,t = the difference between firm i’s return on assets and the mean return on
assets for its industry j, in year t; Dn = 1 if Xi,j,t is less than or equal to 0, and 0 otherwise;
and Dp = 1 if Xi,j,t is greater than 0, and 0 otherwise. A positive and significant β 2j
indicates that firms in industry j with a return above the median are able of maintain
this situation over time, suggesting less competition. We give SPA a value of 0 for firms
in industries where β 2j is positive and significant, and 1 otherwise.
Throughout all the industry-based measures of competition, except for HiTech and
SPA, which are defined as described above at the industry level, we give each of the
other five proxies a value of 1 whenever the industry-year value for each measure is
above or below (depending on how each measure is calculated) the median of the
sample-year.17
Regarding our second set of measures, which capture firm-specific aspects of
competition, we look at three proxies: FirmSalesGrowth, FirmMarkUp and R&D intensity
(HiR&D). Regarding sales growth, we expect that firms with large growth in sales
suffer larger competitive pressures and would be penalized if they give away infor-
mation on how they have been able to sustain their growth rates. FirmSalesGrowth is
a dummy variable taking a value of 1 if firm’s growth in sales is above the median
for the industry-year, and 0 otherwise. Our second proxy is the markup defined in
Allayannis and Ihrig (2001) as mentioned before, calculated at the firm level. Firms
with a markup lower than the industry-year median are assigned a value of 1, and 0
otherwise. Finally, we focus on R&D intensity, assuming that firms more intensive in
R&D face tougher competition. Franko (1989) shows that R&D intensity is linked to
future growth in sales, and that more intensive R&D firms will therefore be subject
to greater competitive pressures. We therefore assume that these firms might suffer
costs in case they provide additional information about their activities. An additional
explanation as to how R&D intensity captures competitive pressures is provided by
Vives (2008), who shows that firms that suffer competitive pressures are more likely to
resort to investments in R&D to survive. We create a dummy variable, HiR&D, taking a
17 We follow Valta (2012) and use dummy variables because this allows an easier economic interpretation
of the coefficients and because with the dummy variable we reduce problems introduced by measurement
errors in the construction of each of the variables.
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382 BLANCO, GARCIA LARA AND TRIBO
value of 1 for firms with R&D levels above the industry-year median, and 0 otherwise.
We measure R&D as the ratio of R&D expenses to sales.18
Finally, we also introduce the measures of competition in the asset pricing tests.
In particular, we add an additional factor that captures competition (in the reported
tables, we use the Herfindahl index), and analyze whether after including this
additional factor the quality of segment disclosure is still a priced risk factor.19
4. RESULTS
In Table 2 we show the pairwise correlations between the quantity of voluntary segment
information score (Qtt Seg) and firm characteristics. Much as expected, business and
geographic diversification are very strongly correlated with Qtt Seg (31.2 percent and
18 When R&D is a missing value, we give it a value of 0. If it is the case that some of these firms conduct
R&D, we are then underestimating the differential moderating effect of competition in the connection from
voluntary disclosure to the cost of capital. Thus, if anything, this would bias results against our hypotheses.
19 We do not consider the effects of competition on our other two sets of tests (analysts’ forecast errors and
the covariance of returns) as they both are intended to capture mostly the positive informational effects of
disclosure, and thus are not expected to be substantially affected by competition.
20 The sample finishes in 2006 as the data on the subsidiaries (needed to create Qlt Seg) cannot be collected
in a standardized fashion after that year.
21 We assume the number of subsidiaries does not change if the data are not available for one year (i.e., if
a firm has no data for 2004, we assume that the number of subsidiaries is equal to that of 2005). Results are
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Table 1
Descriptive Statistics
N Mean Std. Dev. 10% 25% Median 75% 90%
Table 1
Continued
N Mean Std. Dev. 10% 25% Median 75% 90%
rEX-ANTE 10,002 0.1253 0.0416 0.0936 0.1023 0.1131 0.1632 0.1921
Beta 10,002 1.1765 0.9368 0.3599 0.9133 1.0462 1.3680 2.2228
Cov (ri , rsector ) 10,002 0.0161 0.1668 −0.0513 −0.0137 0.0000 0.0192 0.0739
Realized Returns 102,024 0.0161 0.2394 −0.2022 −0.0814 0.0017 0.0806 0.2145
Excess Realized Returns 102,024 0.0133 0.2394 −0.2052 −0.0841 −0.0008 0.0780 0.2117
The sample consists of 10,002 firm-year observations for the period 2001–2006. Qtt Seg = voluntarily disclosed business and geographic segment reporting items.
Qlt Seg = the regression residuals obtained from a regression of the firm’s year t. Qtt Seg on controls and determinants of segment disclosure as defined in the main
text. Qtt Seg Bus = the number of voluntary disclosure elements found in the sample firms for business segment disclosure. Qlt Seg Bus = the regression residuals
obtained from a regression of the firm’s year t Qtt Seg Bus on control and determinants of segment disclosure. Qtt Seg Geo = the number of voluntary disclosure
elements found in the sample firms for geographic segment disclosure. Qlt Seg Geo = the regression residuals obtained from a regression of the firm’s year t Qtt Seg Geo
on controls and determinants of segment disclosure. Earnings Qlt = the absolute value, multiplied by −1, of discretionary accruals calculated as the residual of the
modified version of the Jones (1991) accruals model (Dechow et al., 1995), as applied to total accruals. Business Diversification = number of different sectors in which
|bid−as k|
the firm operates. Geographic Diversification = number of different countries where the firm operates. Information Asymmetries = bid-ask spread, calculated as (bid+as k)/2
measured in t-1. Size = the firm’s market value of equity measured at the beginning of fiscal year 2001–2006. B/M = the firm’s book-to-market ratio measured at the
beginning of fiscal year 2001–2006. Leverage = debt-to-total assets ratio in percentage. Audit Firm = 1 if auditor firm is a Big-Four firm and 0 otherwise. Listing Status
= 1 if firm is listed on the NYSE or NASDAQ and 0 otherwise. Proprietary Costs = Herfindahl index in percentage, as described in the text. New Financing = 1 if the
BLANCO, GARCIA LARA AND TRIBO
firm has issued new debt or equity and 0 otherwise. Profitability = return on assets. Age = the difference between the first year when the firm appears in CRSP and the
current year. Forecast Error = Analysts’ forecast errors. It is calculated as forecast in t-1 of eps for year t – actual eps of year t, scaled by the absolute value of actual eps in
C
year t. DevForecast = deviation of analysts’ forecasts. It is calculated as the standard deviation of analysts’ forecasts of eps for the year t. Number of Analysts = number of
eps forecasts of the firm in year t. rEX-ANTE is the mean of the four estimates for the implied cost of equity capital, as described in Section 3.ii.c. Beta = coefficient from
firm-specific CAPM regression using the 60 months preceding fiscal year 2001–2006. Cov (ri , rsector ) = mean annual covariance of the monthly return of a firm with
the monthly return of the sector in which the firm operates. Realized Returns = monthly realized returns. Excess Realized Returns = monthly excess realized returns over
the risk free rate.
logarithm of the firm’s market value of equity measured at the beginning of fiscal year 2001–2006. B/M = the logarithm of the firm’s book-to-market ratio measured
at the beginning of fiscal year 2001–2006. Leverage = debt-to-total assets ratio in percentage. Audit Firm = 1 if auditor firm is a Big-Four and 0 otherwise. Listing Status
N S
= 1 if firm is listed on the NYSE or NASDAQ and 0 otherwise. Proprietary Costs = Herfindahl index in percentage, calculated as Herf j = i−1 ( Sijj )2 , where Sij =
business i’s sales in industry j, as defined by two-digit SIC code; Sj = the sum of sales for all firms in industry j. New Financing = 1 if the firm has issued new debt or
equity and 0 otherwise. Profitability = percentile rank of return on assets. Age = the difference between the first year when the firm appears in CRSP and the current
year.
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386 BLANCO, GARCIA LARA AND TRIBO
Table 3
Industry Fixed Effect Regression of the Quantity of Voluntary Segment
Disclosures (Qtt Seg) on its Determinants and Controls
Variable Expected sign Coefficient (p-value)
Business Diversification + 5.2727
(0.000)
Geographic Diversification + 0.2532
(0.000)
Information Asymmetries + 2.9581
(0.013)
Size + 3.9419
(0.000)
B/M + 3.9496
(0.000)
Earnings Qlt + 8.0612
(0.000)
Leverage + 0.0844
(0.000)
Audit Firm + 2.3874
(0.000)
Listing Status + 6.4297
(0.000)
Proprietary Costs - −0.4776
(0.000)
New Financing + 1.6418
(0.000)
Profitability +/− −0.0301
(0.000)
Age +/− 0.1173
(0.000)
Cons 2.4034
(0.173)
R2 0.2958
The sample consists of 10,002 firm-year observations for the period 2001–2006. Qtt Seg = voluntarily
disclosed segment reporting items. Business Diversification = number of different sectors in which the firm
operates. Geographic Diversification = number of different countries where the firm operates. Information
|bid−as k|
Asymmetries = bid-ask spread, calculated as (bid+as k)/2 measured in t−1. Size = the logarithm of the firm’s
market value of equity measured at the beginning of fiscal year 2001–2006. B/M = the logarithm of the
firm’s book-to-market ratio measured at the beginning of fiscal year 2001–2006. Earnings Qlt = the absolute
value, multiplied by −1, of discretionary accruals calculated as the residual of the modified version of the
Jones (1991) accruals model (Dechow et al., 1995), as applied to total accruals. Leverage = debt-to-total assets
ratio in percentage. Audit Firm = 1 if auditor firm is a Big-Four firm and 0 otherwise. Listing Status = 1 if
firm is listed on the NYSE or NASDAQ and 0 otherwise. Proprietary Costs = Herfindahl index in percentage,
N S
calculated as Herf j = i−1 ( Sijj )2 , where Sij = business i’s sales in industry j, as defined by two-digit SIC
code; Sj = the sum of sales for all firms in industry j. New Financing = 1 if the firm has issued new debt or
equity and 0 otherwise. Profitability = percentile rank of return on assets. Age = the difference between the
first year when the firm appears in CRSP and the current year.
10.5 percent respectively). Also, information asymmetries are positively correlated with
Qtt Seg. Earnings quality is significantly and positively related to Qtt Seg (21.8 percent).
robust to the use of a smaller sample including only firms with available data on subsidiaries for all the years
of the period under study.
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SEGMENT DISCLOSURE AND COST OF CAPITAL 387
In Table 3 we show the results of an industry fixed effect regression of Qtt Seg,
our proxy for the quantity of segment disclosure, on the determinants of segment
disclosure. We take the decile ranks of the residuals of this regression as our proxy for
the quality of segment disclosure (Qlt Seg). The results show that firms operating in a
higher number of industry sectors and in more countries provide more comprehensive
segment information. Also, we find that firms with higher information asymmetries
provide more segment information. This is consistent with firms providing more
segment information to reduce uncertainties about the firm. Results also show that
the quantity of segment disclosure (Qtt Seg) increases with firm size, the book-to-
market ratio, earnings quality, leverage, being audited by a Big-Four firm, being listed
on the NYSE or NASDAQ, issuing new financing and firm age, and decreases with
profitability and proprietary costs. This latter result conforms to the underpinnings
behind H2, that is, that more competition diminishes firms’ incentives for disclosing
information. All of the controls are significantly associated with quantity of segment
information. Regarding the fitness of the model, the results show that the determi-
nants of disclosure that we consider explain a significant amount of the variation in
Qtt Seg (29.58 percent). These results suggest that our index of voluntary segment
information (Qtt Seg) is a valid measure of disclosure. Our results are robust to the
use of geographic and business segment quantity measures separately, instead of the
aggregate measure Qtt Seg.
22 We do not find that earnings quality reduces forecast errors (the coefficient on earnings quality is not
significant at conventional levels). However, in an additional unreported sensitivity test we use a dummy
variable to capture earnings quality. We assign a value of 1 to firms with earnings quality above the median,
and 0 otherwise. We do this in an attempt to reduce measurement error in the earnings quality proxy. When
we use the dummy instead of the continuous variable the coefficient on earnings quality becomes negative
and significant, consistent with earnings quality decreasing forecast errors. The use of this alternative
earnings quality proxy does not affect the results of the other variables of interest. That is, the coefficient on
segment disclosure quality remains negative and significant at conventional levels.
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388
Table 4
Industry Fixed Effect Regressions of Analysts’ Forecast Errors on Segment Disclosure Quality (Qlt Seg) and Controls
Expected Coef. Coef. Coef. Coef. Coef. Coef.
sign (p-value) (p-value) (p-value) (p-value) (p-value) (p-value)
Qlt Segt – −0.0074 −0.0073 −0.0197 −0.0196 −0.0072 −0.0072
(0.006) (0.000) (0.011) (0.011) (0.015) (0.015)
Earnings Qltt – 0.0286 0.0286 0.0389
(0.696) (0.696) (0.641)
Number of analystst – −0.0017 −0.0017 −0.0018 −0.0017 −0.0021 0.0389
(0.285) (0.292) (0.285) (0.292) (0.256) (0.266)
DevForecast + 0.5968 0.5974
(0.000) (0.000)
Ortho(DevForecast)t 0.0607 0.0608
(0.000) (0.000)
DevForecastt-1 0.5556 0.5564
(0.000) (0.000)
Sizet – −0.0687 −0.0692 −0.0687 −0.0692 −0.0731 −0.0739
(0.000) (0.000) (0.000) (0.000) (0.000) (0.000)
Cons 0.7549 0.7605 0.7492 0.7549 0.7947 0.8026
(0.000) (0.000) (0.000) (0.000) (0.000) (0.000)
BLANCO, GARCIA LARA AND TRIBO
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in t−1 of eps for year t – actual eps of year t, scaled by actual eps in year t. Qlt Seg = the decile-ranked residuals from a regression of the firm’s year t. Qtt Seg on
determinants of segment disclosure and controls (Business Diversification, Geographic Diversification, Information Asymmetries, Size, Growth, Leverage, Earnings Qlt, Audit
Firm, Listing Status, Proprietary Costs, New Financing, Profitability, Age). Earnings Qlt = the absolute value, multiplied by −1, of discretionary accruals calculated as the
residual of the modified version of the Jones (1991) accruals model (Dechow et al., 1995), as applied to total accruals. Number of analysts = number of eps forecasts
of the firm in year t. DevForecast = deviation of analysts’ forecasts. It is calculated as the standard deviation of analysts’ forecasts. Ortho(DevForecast) is the residual of a
regression of DevForecast on Qlt Seg. Size = the logarithm of the firm’s market value of equity measured at the beginning of fiscal year 2001–2006.
Table 5
Industry Fixed Effect Regressions of Firm’s Returns Covariance with the Returns
of the Rest of Firms in the Same Industry on Segment Disclosure Quality (Qlt Seg)
and Controls
Expected sign Coef. (p-value) Coef. (p-value) Coef. (p-value)
Qlt Seg − −0.0010 −0.0010 −0.0011
(0.000) (0.000) (0.006)
Earnings Qlt − −0.0242
(0.038)
Size − −0.0032 −0.0028
(0.000) (0.001)
B/M + 0.0140 0.0146
(0.000) (0.000)
Proprietary Costs − −0.0825 −0.0825
(0.091) (0.091)
Leverage + 0.0001 0.0001
(0.048) (0.027)
Business Diversification − −0.0016 −0.0016
(0.160) (0.161)
Geographic Diversification − −0.0002 −0.0001
(0.474) (0.502)
Listing Status − −0.0152 −0.0110
(0.027) (0.122)
Profitability + 0.0001 0.0001
(0.005) (0.003)
Age − −0.0002 −0.0002
(0.067) (0.093)
Cons 0.0573 0.1133 0.1046
(0.000) (0.000) (0.000)
R2 0.0072 0.0272 0.0278
The sample consists of 10,002 firm-year observations for the period 2001–2006. Cov (ri , rsector ) = mean
annual covariance of the monthly return of a firm with the monthly return of the firms in the industry
sector in which the firm operates. Qlt Seg = the decile-ranked residuals from a regression of the firm’s year t.
Qtt Seg on determinants of segment disclosure and controls (Business Diversification, Geographic Diversification,
Information Asymmetries, Size, Growth, Leverage, Earnings Qlt, Audit Firm, Listing Status, Proprietary Costs, New
Financing, Profitability, Age). Earnings Qlt = the absolute value, multiplied by −1, of discretionary accruals
calculated as the residual of the modified version of the Jones (1991) accruals model (Dechow et al.,
1995), as applied to total accruals. Size = the logarithm of the firm’s market value of equity measured at
the beginning of fiscal year 2001–2006. B/M = the logarithm of the firm’s book-to-market ratio measured
at the beginning of fiscal year 2001–2006. Proprietary Costs = Herfindahl index in percentage, calculated
N S 2
as Herf j = i=1 ( Sijj ) , where Sij = business i’s sales in industry j, as defined by two-digit SIC code; Sj
= the sum of sales for all firms in industry j. Leverage = debt-to-total assets ratio in percentage. Business
Diversification = number of different sectors in which the firm operates. Geographic Diversification = number
of different countries where the firm operates. Listing Status = 1 if firm is listed on the NYSE or NASDAQ
and 0 otherwise. Profitability = percentile rank of return on assets. Age = the difference between the first
year when the firm appears in CRSP and the current year.
(ii) Firm’s Returns Covariance with other Firms’ Returns and Segment Disclosure
In Table 5 we show the results of regressing the covariance between the firm’s
returns and returns of the firms operating in the same industry sector on the
quality of segment information and controls. Once we focus on the last column of
the table, where we use the full model, including all controls, the coefficient on
segment information quality is negative and significant (coeff. = −0.0011, p = 0.006).
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390 BLANCO, GARCIA LARA AND TRIBO
Thus, results are consistent with better segment information reducing the covariance
between the firm’s returns and returns of the rest of the firms in the same industry.
In terms of economic significance, if the firm moves to the next decile of better
segment reporting quality, the covariance between the firm returns with the returns
of all other firms in the same industry decreases by 0.11 percentage points (see the full
model in the last column). Bearing in mind that the average covariance for all firms
in the sample is 1.61 percent (see Table 1), the reduction introduced by improving
segment reporting is substantial. In the Lambert et al. (2007) setting, these results
are consistent with firms providing high quality segment disclosure enjoying a lower
cost of capital. Results are qualitatively similar if we do not control by earnings quality
(second column), or if we estimate the model without controls (first column).
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Table 6
from firm-specific CAPM regression using the 60 months preceding fiscal year 2001–2006. Leverage = debt-to-total assets ratio in percentage. Business Diversification =
number of different sectors in which the firm operates. Geographic Diversification = number of different countries where the firm operates.
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392 BLANCO, GARCIA LARA AND TRIBO
Table 7
Industry Fixed Effect Regressions of Implied Cost of Equity Capital (rEX-ANTE ) on
Segment Disclosure Quality (Qlt Seg) and Controls
Expected Coef. Coef. Coef. Coef.
Variable sign (p-value) (p-value) (p-value) (p-value)
Qlt Seg − −0.0023 −0.0024 −0.0025
(0.000) (0.000) (0.000)
Earnings Qlt − −0.0321
(0.000)
Size − −0.0035 −0.0036 −0.0034
(0.000) (0.000) (0.000)
B/M + 0.0080 0.0080 0.0080
(0.000) (0.000) (0.000)
Beta +/− 0.0052 0.0052 0.0051
(0.000) (0.000) (0.000)
Leverage + 0.0001 0.0001 0.0001
(0.000) (0.000) (0.000)
Business Diversification − −0.0015 −0.0015 −0.0011
(0.000) (0.003) (0.002)
Geographic Diversification − −0.0007 −0.0007 −0.0007
(0.000) (0.000) (0.000)
Cons 0.1699 0.1588 0.1829 0.1930
(0.000) (0.000) (0.000) (0.000)
R2 0.0716 0.0513 0.0896 0.1061
The sample consists of 10,002 firm-year observations for the period 2001–2006. rEX-ANTE is the mean of the
four estimates for the implied cost of equity capital, as described in Section 3.ii.c. Qlt Seg = the decile-ranked
residuals from a regression of the firm’s year t. Qtt Seg on determinants of segment disclosure and controls
(Business Diversification, Geographic Diversification, Information Asymmetries, Size, Growth, Leverage, Earnings Qlt,
Audit Firm, Listing Status, Proprietary Costs, New Financing, Profitability, Age). Earnings Qlt = the absolute value,
multiplied by −1, of discretionary accruals calculated as the residual of the modified version of the Jones
(1991) accruals model (Dechow et al., 1995), as applied to total accruals. Size = the logarithm of the firm’s
market value of equity measured at the beginning of fiscal year 2001–2006. B/M = the logarithm of the
firm’s book-to-market ratio measured at the beginning of fiscal year 2001–2006. Beta = coefficient from
firm-specific CAPM regression using the 60 months preceding fiscal year 2001–2006. Leverage = debt-to-total
assets ratio in percentage. Business Diversification = number of different sectors in which the firm operates.
Geographic Diversification = number of different countries where the firm operates.
that moving from the best to the worst decile of voluntary disclosure increases cost of
capital by around 2 percent. Overall, our results suggest that firms providing better
quality segment information enjoy a lower cost of equity capital.
Regarding the moderating effect of competition, in Table 8 we show results of re-
gressions of implied cost of equity capital on segment disclosure quality, competition,
earnings quality and controls. In Table 8, Panel A, we report the results using industry-
based measures of competition, and in Panel B, we show the results using the measures
of competition at the firm level. Remarkably, regardless of the measure of competition
that we use, the effect of segment disclosure on cost of equity capital is negative. Also,
consistent with our expectations, this effect is less negative in industries and for firms
that operate in a more competitive environment (positive coefficient of Qlt Seg ×
Competition in all specifications of Panels A and B). Hence, the cost of equity capital
effect of segment disclosure is smaller for firms subject to competitive pressures.24
24 When we use Herf and Exist-Comp to measure competition (columns 5 and 6 in Table 8, Panel A), we
exclude the Herfindahl index from the estimation of Equation (1), where we determine Qlt Seg. We do so
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Table 8
Industry Fixed Effect Regressions of Implied Cost of Equity Capital (rEX-ANTE ) on Segment Disclosure Quality (Qlt Seg)
Panel A: Industry-level competition and controls
HiTech Industry Sales Growth Industry MarkUp NumFirms Herf Exist-Comp SPA
Variable Expected sign Coef. (p-value) Coef. (p-value) Coef. (p-value) Coef. (p-value) Coef. (p-value) Coef. (p-value) Coef. (p-value)
Table 8
Continued
Panel B: Firm-level competition and controls
Firm Sales Growth Firm MarkUp HiR&D
Variable Expected sign Coef. (p-value) Coef. (p-value) Coef. (p-value)
Qlt Seg − −0.0022 −0.0028 −0.0028
(0.000) (0.000) (0.000)
Competition +/− −0.0011 0.0016 −0.0059
(0.093) (0.135) (0.105)
Qlt Seg × Competition + 0.0004 0.0006 0.0007
(0.047) (0.063) (0.089)
Earnings Qlt − −0.0277 −0.0275 −0.0298
(0.000) (0.000) (0.000)
Size − −0.0032 −0.0031 −0.0031
(0.000) (0.000) (0.000)
B/M + 0.0044 0.0068 0.0080
(0.000) (0.000) (0.000)
Beta +/− 0.0050 0.0051 0.0053
(0.000) (0.000) (0.000)
Leverage + 0.0002 0.0002 0.0001
(0.000) (0.000) (0.000)
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Geographic Diversification − −0.0004 −0.0004 −0.0005
(0.000) (0.001) (0.001)
Cons 0.1634 0.1663 0.1683
(0.000) (0.000) (0.000)
R2 0.1074 0.1083 0.1083
p-value (β 1 +β 3 ) 0.000 0.000 0.000
(Continued)
the logarithm of the firm’s market value of equity measured at the beginning of fiscal year 2001–2006. B/M = the logarithm of the firm’s book-to-market ratio. Beta
= coefficient from firm-specific CAPM regression using the preceding 60 months. Leverage = debt-to-total assets ratio in percentage. Business Diversification = number
of different sectors in which the firm operates. Geographic Diversification = number of different countries where the firm has subsidiaries.
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396 BLANCO, GARCIA LARA AND TRIBO
For example, when we use as a proxy for competitive pressure HiTech (Column 1,
Panel A), the reduction in the cost of equity capital as we move from the lowest decile
of quality of voluntary segment reporting to the highest decile is 72 basis points less
intense once we compare competitive industries (HiTech = 1) versus non-competitive
industries (HiTech = 0).25 Also, it is noteworthy that the overall effect is still negative
and statistically significant (p < 0.001 for all the competition measures). That is, once
we control for competition the effect of segment disclosure on cost of equity capital is
less pronounced, but it is still negative. This result conforms to H2.
Finally, given the measurement problems of implied estimates of cost of capital
identified by Easton and Monahan (2005), we use a different risk proxy as dependent
variable in Specification (4): returns volatility. We show the results in Table 9. In
the first column we just include the controls, and we can see that returns volatility
is associated with other risk proxies and that the signs of these associations are as
expected. In the second column we include Qlt Seg as the only explanatory variable,
and, as expected, it is negative and significant (−0.0001, p = 0.079). In the third
column we include all controls, except earnings quality, and the coefficient on
segment disclosure quality is still negative and significant at conventional levels. Finally,
in the last column we also control for earnings quality, which has a negative coefficient,
and the result for Qlt Seg does not change qualitatively.
to avoid any potential mechanical relations that might arise. However, results do not change qualitatively
regardless of whether we include the Herfindahl index or not in the estimation of Equation (1).
25 This is the result of multiplying the coefficient of Qlt Seg × Competition (β 3 ) times 9 deciles = 0.0008 ×
9 = 0.0072 = 72 basis points.
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Table 9
Industry Fixed Effect Regressions of Returns Volatility on Segment Disclosure Quality (Qlt Seg) and Controls
Variable Expected sign Coef. (p-value) Coef. (p-value) Coef. (p-value) Coef. (p-value)
Qlt Seg − −0.0001 −0.0002 −0.0002
(0.079) (0.024) (0.016)
The sample consists of 10,002 firm-year observations for the period 2001–2006. Returns volatility is the standard deviation of daily returns over a 12 month window.
Qlt Seg = the decile-ranked residuals from a regression of the firm’s year t Qtt Seg on determinants of segment disclosure and controls (Business Diversification, Geographic
Diversification, Information Asymmetries, Size, Growth, Leverage, Earnings Qlt, Audit Firm, Listing Status, Proprietary Costs, New Financing, Profitability, Age). Earnings Qlt = the
absolute value, multiplied by −1, of discretionary accruals calculated as the residual of the modified version of the Jones (1991) accruals model (Dechow et al. 1995),
as applied to total accruals. Size = the logarithm of the firm’s market value of equity measured at the beginning of fiscal year 2001–2006. B/M = the logarithm of the
firm’s book-to-market ratio measured at the beginning of fiscal year 2001–2006. Beta = coefficient from firm-specific CAPM regression using the 60 months preceding
fiscal year 2001–2006. Leverage = debt-to-total assets ratio in percentage. Business Diversification = number of different sectors in which the firm operates. Geographic
Diversification = number of different countries where the firm operates.
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398 BLANCO, GARCIA LARA AND TRIBO
Table 10
Asset Pricing Based Tests: Relation between Realized Returns and Segment
Disclosure, Descriptive Statistics
Panel A: Summary statistics
Variable Mean Std. Dev. Annualized return
RMRF 0.0032 0.0418 3.9083%
SMB 0.0073 0.0296 9.1204%
HML 0.0085 0.0294 10.6906%
UMD 0.0093 0.0431 11.7489%
LIQ 0.0063 0.0325 7.8275%
HILOQlt Seg −0.0058 0.0263 −7.1864%
HILOEarnings Qlt −0.0031 0.0431 −3.7841%
Panel B: Correlation Matrix
HILO HILO
RMRF SMB HML UMD LIQ QltSeg Earnings Qlt
RMRF 1
SMB 0.3318 1
HML −0.4658 −0.2417 1
UMD 0.0128 0.1893 0.1732 1
LIQ −0.5893 −0.1783 0.4389 −0.1472 1
HILOQlt Seg 0.0314 −0.2165 0.4023 0.1726 0.2372 1
HILOEarnings Qlt 0.0621 −0.2423 0.4984 0.1468 0.2868 0.3943 1
The sample consists of 102,024 firm-month observations for the period 2001–2006. Bold numbers in Panel
B are significant at p < 0.05. RMRF is excess return on the value-weighted market portfolio. Excess returns
equal the value-weighted return on the portfolios less the risk free rate. SMB is the value-weighted size-
mimicking portfolio return. HML is the value-weighted book-to-market-mimicking portfolio return. UMD is
the value-weighted momentum-mimicking portfolio return. LIQ is the value-weighted liquidity-mimicking
portfolio return. HILOQlt Seg is the value-weighted Qlt Seg-mimicking portfolio return. HILOEarnings Qlt is
the value-weighted Earnings Qlt-mimicking portfolio return.
(five, including liquidity) factor model, as firms providing poor segment information
quality have greater average excess returns unexplained.26
In the second column of Table 11, we include an additional factor (HERF) to
consider the level of competition. To create HERF we take a long position on the two
quintiles with the lowest Herf index and a short position on the two quintiles with the
highest Herf index. We find that HERF is not a risk factor (p = 0.318) and even when
we take into account the competition level, the effect of segment disclosure on cost of
equity capital is negative and significant (−0.1694 and p = 0.000).
In Table 12, Panel A shows the average factor loadings and average R2 of time-
series regressions of monthly contemporaneous portfolio excess stock returns (stock
return minus the risk-free rate) on the three Fama–French factors, the momentum and
liquidity factors, the Qlt Seg factor and the Earnings Qlt factor. We report the results
of averaging multivariate betas from 25 value-weighted portfolios sorted by Size and
B/M. We find that the sensitivity of portfolios’ returns to segment information quality
26 The positive coefficient of RMRF, which is connected to some extent to the CAPM beta, may be at odds
with the lower beta that we expect from a fixed portfolio in which there is an increase in voluntary segment
information (see Table 5). However, we should note that the voluntary segment information hedge portfolio
– long (short) – in high (low) voluntary segment information quality – is composed of different stocks that
are rebalanced each month. Hence the hedge portfolio is not fixed but changes every month.
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SEGMENT DISCLOSURE AND COST OF CAPITAL 399
Table 11
Time-Series Regressions of HEDGE Qlt Seg on the Fama–French, Momentum and
Liquidity Factors
Coef. (p-value) Coef. (p-value)
RMRF 0.0219 0.0252
(0.000) (0.000)
SMB −0.0103 −0.0114
(0.000) (0.000)
HML 0.0318 0.0324
(0.000) (0.000)
UMD 0.0593 0.0602
(0.001) (0.000)
LIQ 0.0347 0.0385
(0.083) (0.062)
HERF 0.0029
(0.318)
is negative (−0.0086 with p = 0.004 if we do not include the earnings quality factor,
and −0.0083 with p = 0.005 if we do). The earnings quality factor is also significantly
negative, but with a larger standard error (p = 0.096). Our results are robust to the
inclusion of competition (HERF) as an additional factor in the Fama–French model
(see last column of Panel A), and to the use of the CAPM (reported in Table 12, Panel
B) instead of the augmented Fama–French model.
As a final test to study whether segment reporting quality is a priced factor, in
Table 13 we present the coefficients from 72 monthly cross-sectional regressions
of excess value-weighted portfolio returns on portfolio factor loadings (the slope
coefficients from the regressions in Table 12). We find that the risk premium linked
to segment information quality is negative (−0.3943; p = 0.004 in column 3, Panel A),
that is, firms providing better quality segment information have lower excess realized
returns. However, earnings quality bears no significant risk premium (−0.0952; p =
0.119). This indicates that earnings quality, as we measure it, is weakly associated with
excess realized returns. Our results regarding earnings quality are in line with the
evidence in Core et al. (2008). Overall, our findings indicate that firms with better
quality segment information enjoy a lower cost of equity capital. As in the first stage
reported in Table 12, results are robust to the use of the CAPM (Panel B).
Finally, we include the HERF factor to consider the level of competition. As in
Table 12, we find that competition is not a risk factor (p = 0.324 in column 4, Panel
A) and the sign of the coefficients barely changes. Overall, even when we include the
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400 BLANCO, GARCIA LARA AND TRIBO
Table 12
Average Factor Loadings across Fama–French 25 Size-B/M Portfolios
Panel A: 5 Factor Model Panel B: CAPM
Coef. (p-value) Coef. (p-value)
SMB 0.4983 0.4992 0.5002 0.5001
(0.001) (0.001) (0.001) (0.001)
HML 0.2934 0.2875 0.2865 0.2866
(0.004) (0.004) (0.004) (0.005)
UMD 0.0396 0.0383 0.0398 0.0399
(0.006) (0.004) (0.005) (0.005)
LIQ 0.0289 0.0283 0.0346 0.0328
(0.103) (0.104) (0.093) (0.095)
HERF 0.0243
(0.293)
RMRF 1.0002 1.0004 1.0004 1.0001 1.1679 1.1686 1.1698
(0.000) (0.000) (0.000) (0.000) (0.000) (0.000) (0.000)
HILO Qlt Seg −0.0086 −0.0083 −0.0078 −0.0106 −0.0105
(0.004) (0.005) (0.006) (0.005) (0.004)
HILO Earnings Qlt −0.0009 −0.0006 −0.0009
(0.096) (0.106) (0.085)
Cons 0.0238 0.0302 0.0295 0.0294 0.0983 0.0981 0.0978
(0.000) (0.000) (0.000) (0.000) (0.000) (0.000) (0.000)
R2 0.9014 0.9085 0.9136 0.9139 0.7832 0.7856 0.7893
GRS-stat 2.38 3.61 4.93 5.02 4.89 4.92 4.94
GRS p-value <0.01 <0.01 <0.01 <0.01 <0.01 <0.01 <0.01
This table presents average factor loadings and average R2 of time-series regressions of monthly contem-
poraneous portfolio excess stock returns (stock return minus the risk-free rate) on the four Fama–French
factors, the Liquidity factor, the Qlt Seg factor and the Earnings Qlt factor. The sample consists of 102,024
firm-month observations for the period 2001–2006. We form 25 portfolios sorting stocks into quintiles based
on Size-B/M. SMB is the value-weighted size-mimicking portfolio return. HML is the value-weighted book-
to-market-mimicking portfolio return. UMD is the value-weighted momentum-mimicking portfolio return.
LIQ is the value-weighted liquidity-mimicking portfolio return. HERF is the value-weighted Herf-mimicking
portfolio return. RMRF is excess return on the value-weighted market portfolio. Excess returns equal the
value-weighted return on the portfolios less the risk free rate. HILOQlt Seg is the value-weighted Qlt Seg-
mimicking portfolio return. HILOEarnings Qlt is the value-weighted Earnings Qlt-mimicking portfolio return.
The reported p-values are calculated from the portfolio-specific standard errors of the average parameters
(25 coefficients on each variable). The GRS statistic is the Gibbons et al. (2005) test on whether the
estimated intercepts are jointly zero.
competition level, results are consistent with segment reporting quality being a priced
factor and with investors rewarding firms that report better segment disclosure with a
lower cost of equity capital.27
As an additional battery of robustness tests, we also run asset pricing tests using as
test assets a set of 25 portfolios from the intersection of the quintiles of B/M with the
quintiles of Qlt Seg. We run also the test using as test assets a set of 25 portfolios from
the intersection of the quintiles of Size with the quintiles of Qlt Seg. Finally, we repeat
the tests using as a test asset a set of 100 portfolios of Qlt Seg. The results are robust
across these different test asset specifications. Overall, the findings of the asset pricing
tests show that better segment reporting quality is associated with a lower cost of equity
capital.
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SEGMENT DISCLOSURE AND COST OF CAPITAL 401
Table 13
Monthly Regressions of Returns of 25 Size-B/M Portfolios on Factor Loadings
Panel A: FF 5 Panel B: CAPM
Factor Model Coef. (p-value) Coef. (p-value)
SMB 0.2532 0.2532 0.2624 0.2619
(0.131) (0.134) (0.130) (0.125)
HML 0.3995 0.4123 0.4213 0.4226
(0.000) (0.000) (0.000) (0.000)
UMD 0.0321 0.0392 0.0392 0.0393
(0.004) (0.003) (0.001) (0.001)
LIQ 0.0219 0.0278 0.0283 0.0286
(0.113) (0.109) (0.106) (0.106)
HERF 0.0980
(0.324)
RMRF 0.3123 0.3120 0.3190 0.3053 0.4328 0.4216 0.4209
(0.101) (0.104) (0.103) (0.101) (0.005) (0.008) (0.009)
HILO Qlt Seg −0.3967 −0.3943 −0.3840 −0.4892 −0.4896
(0.004) (0.004) (0.003) (0.001) (0.000)
HILO Earnings Qlt −0.0952 −0.0956 −0.1025
(0.119) (0.121) (0.120)
Cons 0.7934 0.8025 0.8238 0.8268 0.9318 0.8993 0.8849
(0.000) (0.000) (0.000) (0.000) (0.000) (0.000) (0.000)
R2 0.5482 0.5570 0.5608 0.5616 0.4567 0.4783 0.4786
This table presents average coefficients from 72 monthly cross-sectional regressions of excess value-weighted
portfolio returns on portfolio factor loadings (the slope coefficients from the regressions in Table 12, Panel
A). The sample consists of 102,024 firm-month observations for the period 2001–2006. SMB is the value-
weighted size-mimicking portfolio return. HML is the value-weighted book-to-market-mimicking portfolio
return. UMD is the value-weighted momentum-mimicking portfolio return. LIQ is the value-weighted
liquidity-mimicking portfolio return. HERF is the value-weighted Herf-mimicking portfolio return. RMRF
is excess return on the value-weighted market portfolio. Excess returns equal the value-weighted return on
the portfolios less the risk free rate. HILOQlt Seg is the value-weighted Qlt Seg-mimicking portfolio return.
HILOEarnings Qlt is the value-weighted Earnings Qlt-mimicking portfolio return. The reported p-values are
calculated from the standard errors of the average monthly parameter estimates following the Fama and
MacBeth (1973) procedure.
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402 BLANCO, GARCIA LARA AND TRIBO
segment, and then, for each firm, we calculate the standard deviation of the growth
rate of the different reported segments. The idea behind this measure, which is in line
with the empirical work by Ettredge et al. (2006), is that segment disclosure is of high
quality whenever the standard deviation is high. A high standard deviation implies
that the firm is providing information about segments that are actually different,
and therefore that the information provided is really useful for investors. Using this
alternative measure of disclosure quality we obtain results qualitatively similar to those
reported in the paper. Finally, we also replicate the main tests in the paper excluding
firms with losses, and inferences do not change.
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SEGMENT DISCLOSURE AND COST OF CAPITAL 403
APPENDIX 1
(a) “Its reported revenue, including both sales to external customers and interseg-
ment sales or transfers, is 10 percent or more of the combined revenue, internal
and external, of all operating segments.
(b) The absolute amount of its reported profit or loss is 10 percent or more of
the greater, in absolute amount, of (1) the combined reported profit of all
operating segments that did not report a loss or (2) the combined reported
loss of all operating segments that did report a loss.
(c) Its assets are 10 percent or more of the combined assets of all operating
segments.”
If any given reported segment meets any of these thresholds, we consider the
segment as reported mandatorily.28 If the firm reports segments that do not meet
any of the thresholds in paragraph 18, to analyze whether these additional business
segments are compulsorily or voluntarily reported, we study the requirements of
paragraph 20 of SFAS 131: “If total of external revenue reported by operating segments
constitutes less than 75 percent of total consolidated revenue, additional operating
segments shall be identified as reportable segments (even if they do not meet the
criteria in paragraph 18) until at least 75 percent of total consolidated revenue is
included in reportable segments.” Given this, we sum the revenues of the segments
that meet any of the quantitative thresholds according to paragraph 18. If they
account for 75 percent of consolidated revenue, we consider all the other reported
segments as reported voluntarily. If they do not account for 75 percent of consolidated
28 Given the requirements in paragraph 18.b., it could be the case that we classify a segment as reported
on a voluntary basis when it is in fact reported on a mandatory basis. However, this would bias the results
against our hypotheses given that we predict that only voluntary segment disclosure would produce effects
on a firm’s cost of capital. Hence, an overestimation of voluntary disclosure would, if anything, reduce the
significance of our findings.
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404 BLANCO, GARCIA LARA AND TRIBO
1. Business segment name (as the general information required in paragraph 26)
2. Identifiable assets per segment.
3. Depreciation, depletion and amortization per segment.
4. Equity in earnings per segment.
5. Operating profit per segment.
6. Sales to principal customer per segment.
7. Sales of principal product per segment.
8. Customer name per segment.
9. Investment at equity per segment.
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SEGMENT DISCLOSURE AND COST OF CAPITAL 405
(a) Revenues from external customers (1) attributed to the enterprise’s country
of domicile and (2) attributed to all foreign countries in total from which the
enterprise derives revenues. If revenues from external customers attributed to
an individual foreign country are material, those revenues shall be disclosed
separately. An enterprise shall disclose the basis for attributing revenues from
external customers to individual countries.
(b) Long-lived assets other than financial instruments, long-term customer re-
lationships of a financial institution, mortgage and other servicing rights,
deferred policy acquisition costs, and deferred tax assets (1) located in the
enterprise’s country of domicile and (2) located in all foreign countries in total
in which the enterprise holds assets. If assets in an individual foreign country
are material, those assets shall be disclosed separately.”
Given the above, we consider as reportable geographic segments all geographic seg-
ments available in Compustat (11 items of information for each geographic segment),
and consider the following as mandatory items for each reportable segment:
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406 BLANCO, GARCIA LARA AND TRIBO
APPENDIX 2
ep s 5 − ep s 4
rP EG = (A1)
P0
where epst is earnings per share in year t. We use five-year long-term growth rates from
I/B/E/S to calculate eps4 and eps5 . P0 is the market price of a firm’s stock. To calculate
rPEG , Botosan and Plumlee (2005) use earnings per share forecasts in years 4 and 5
because for rPEG to be meaningful it requires positive changes in forecasted earnings,
and changes between years 4 and 5 are more likely to be positive than changes in
near-term forecasts.
We calculate the MPEG ratio, also proposed by Easton (2004), as follows:
ep s 2 − ep s 1 dp s 1
rMP EG = A + A2 + ; A= (A2)
P0 2P0
where dps is dividends per share. While rPEG assumes that the market expects no
dividends in year t+1, rMPEG relaxes this assumption.
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SEGMENT DISCLOSURE AND COST OF CAPITAL 407
and the proxy proposed by Gode and Mohanram (2003) is the following:
ep s 1 (ep s 2 − ep s 1 ) (γ − 1) + (dp s 1 /P0 )
r GM = A + A2 + × − (γ − 1) ; A = .
P0 ep s 1 2
(A4)
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