Discussion of “The Role of Information Precision in Determining Cost of Equity Capital”

Discussion of “The Role of Information Precision in Determining Cost of Equity Capital” Botosan, Plumlee, and Xie (this issue) demonstrate an association between a proxy for cost of capital and proxies for public and private information precision. These proxies have limitations that suggest caution in interpreting their results, absent evidence of proxy validity. The proxy for cost of capital is based on Value Line's beliefs about expected returns, not actual expected returns. The proxy for private information measures information revealed by analysts, not information used by inside traders. In this paper, Botosan, Plumlee, and Xie (this issue; hereafter BPX) empirically explore the joint effect that public and private information precision have on the cost of equity capital. Their key findings are that more precise public information lowers the cost of capital, while more precise private information raises the cost of capital. The paper considers whether public and private information are substitutes or complements but finds no evidence of an interactive effect. This is an important question with significant policy implications for firms, investors, and regulators. While there is (as the authors discuss) considerable prior literature on the topic, the matter is empirically unsettled, so further evidence is welcome. Also, the authors make an important point that, given the correlation between public and private information, it is essential to control for one when analyzing the effect of the other. The reliability of the results in BPX depends on whether the proxies used in the paper effectively measure the underlying economic constructs. Cost of equity capital is proxied by a formula using Value Line forecasts, while public and private information measures are based on analyst forecast dispersion and accuracy. Most of the following discussion considers how reliable these proxies might be. http://www.deepdyve.com/assets/images/DeepDyve-Logo-lg.png Review of Accounting Studies Springer Journals

Discussion of “The Role of Information Precision in Determining Cost of Equity Capital”

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Publisher
Springer Journals
Copyright
Copyright © 2004 by Kluwer Academic Publishers
Subject
Business and Management; Accounting/Auditing; Corporate Finance; Public Finance
ISSN
1380-6653
eISSN
1573-7136
D.O.I.
10.1023/B:RAST.0000028189.69338.c1
Publisher site
See Article on Publisher Site

Abstract

Botosan, Plumlee, and Xie (this issue) demonstrate an association between a proxy for cost of capital and proxies for public and private information precision. These proxies have limitations that suggest caution in interpreting their results, absent evidence of proxy validity. The proxy for cost of capital is based on Value Line's beliefs about expected returns, not actual expected returns. The proxy for private information measures information revealed by analysts, not information used by inside traders. In this paper, Botosan, Plumlee, and Xie (this issue; hereafter BPX) empirically explore the joint effect that public and private information precision have on the cost of equity capital. Their key findings are that more precise public information lowers the cost of capital, while more precise private information raises the cost of capital. The paper considers whether public and private information are substitutes or complements but finds no evidence of an interactive effect. This is an important question with significant policy implications for firms, investors, and regulators. While there is (as the authors discuss) considerable prior literature on the topic, the matter is empirically unsettled, so further evidence is welcome. Also, the authors make an important point that, given the correlation between public and private information, it is essential to control for one when analyzing the effect of the other. The reliability of the results in BPX depends on whether the proxies used in the paper effectively measure the underlying economic constructs. Cost of equity capital is proxied by a formula using Value Line forecasts, while public and private information measures are based on analyst forecast dispersion and accuracy. Most of the following discussion considers how reliable these proxies might be.

Journal

Review of Accounting StudiesSpringer Journals

Published: Sep 30, 2004

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