Capital Structure, Cost of Capital, and Voluntary Disclosures
This paper develops a model of external financing that jointly determines a firm’s capital structure, its voluntary disclosure policy, and its cost of capital. We study a setting in which investors– who provide financing to a firm in exchange for securities issued by the firm – sometimes incur trading losses when they subsequently trade their securities with a superiorly informed trader. Both the firm’s disclosure policy and the structure of the firm’s securities determine the informational advantage of the superiorly informed trader which in turn determines both the size of investors’ trading losses and the firm’s cost of capital.
In this setting, among other things, we establish: there is a hierarchy of optimal securities that varies with the volatility of the firm’s cash flows, that an increase in the volatility of the firm’s cash flows is associated with: an increase in the amount of debt in the firm’s capital structure; a reduction in the firm’s voluntary disclosures; and an increase in the firm’s cost of capital. The model predicts a negative association between firms’ cost of capital and the extent of information they disclose voluntarily. This negative association does not imply, however, that more expansive voluntary disclosure causes firms’ cost of capital to decline. The paper also documents how imposing mandatory disclosure requirements can alter firms’ voluntary disclosure decisions, their capital structure choices, and their cost of capital.
Bertomeu, Jeremy, Anne Beyer and Ronald A. Dye. 2011. Capital Structure, Cost of Capital, and Voluntary Disclosures. Accounting Review. 86(3): 857.