Assessing the Role of Investor’s Protection Criterion and Improvement of Financial Reporting Quality on Reduction the Cost of Equity Capital

Abstract

According to theoretical foundations, it is important to determine the optimum level of capital financing in order to minimize the cost of capital. Firms’ effort to decrease the information risks and focus on investor’s protection aspects could lead to change in cost of capital. The main purpose of this paper is assessment the impact of investor’s protection criterion and improvement of financial reporting quality on reduction the cost of equity capital. Earnings quality is measured based on the inverse index of residuals absolute values extracted from accruals model. Stockholders’ expected rate of return which extracted from the capital asset pricing model is used to measure the cost of equity capital. Also, investor protection is assessed through various criteria such as separation of chairman’s duty, board independence, internal audit, shareholder with vote right, ownership concentration, adjustment, disclosure of audit fee & managerial compensation. Research samples include 183 firms listed in Tehran Securities & Exchange during the period from March 2012 till March 2018. Research hypotheses analyzed through multivariate regression models using panel data which included firm-year observation and fixed effect method. Findings indicated that earnings quality had significant and negative impact on cost of equity capital; In addition, investor’s protection had significant and negative impact on cost of equity capital. Other evidences documented the key role of corporate governance procedures to protect the investors & shareholders and improvement the quality of financial reporting in order to decrease the cost of equity capital.

Keywords

• cost of equity capital
• financial information quality
• investors protection