Does graph disclosure bias reduce the cost of equity capital?

Abstract

Firms widely use graphs in their financial reports. In this respect, prior research demonstrates that companies use graphs to provide a favourable outlook of performance, suggesting that they try to manage the impression created in users’ perceptions. This study tests whether by means of distorted graphs managers are able to influence users’ decisions in the capital market. By focusing on the effects of distorted graphs on the cost of equity capital, we provide preliminary evidence on one of the possible economic consequences of graph usage. The results of this investigation suggest that graph disclosure bias has a significant, but temporary, effect on the cost of equity. Moreover, our results highlight the important role played by the overall level of disclosure as a conditioning factor in the relationship between graphs and the cost of equity. Consequently, the results of the current study enhance our understanding of the complex interactions that take place in the stock market between information, information intermediaries and investors.

Keywords::

• cost of equity
• disclosure
• graph distortion

Notes

Flora Muiño is at the Departamento de Economía de la Empresa, Universidad Carlos III de Madrid and Marco Trombetta is at the Instituto de Empresa Business School, Madrid.

The authors would like to acknowledge the financial support of the Spanish Ministry of Education through grants SEJ2004–08176‐C02–02 and SEJ2007–67582‐CO2–01/02. They appreciate the invaluable comments of the editor, two anonymous referees and from Salvador Carmona, Juan Manuel Garcia Lara, Miles Gietzmann, Manuel Illueca, Giovanna Michelon, Tashfeen Sohail, seminar participants at Universidad Carlos III (Madrid – Spain), Instituto de Empresa (Madrid – Spain), University of Padova (Italy), participants of the 29th annual EAA meeting (Dublin – Ireland) and participants to the 5th Workshop on Empirical Research in Financial Accounting (Madrid – Spain). All remaining errors are the authors’ responsibility only.

Correspondence should be addressed to: Prof. Marco Trombetta, Instituto de Empresa Business School, Department of Accounting and Management Control, Calle Pinar 15 – 1B, 28006, Madrid (Spain). Tel: [phone]. Fax: [phone]. E‐mail: [email protected].