Voluntary Internal Control Information Disclosure And The Cost Of Equity Capital

This paper investigates the relationship between voluntary internal control information disclosure and cost of equity capital using a sample of A-Share non-financial public traded companies in Shanghai Stock Exchange (SSE) from2008-2011based on voluntary internal control information disclosure. Cost of equity capital is the lowest required risk of return of shareholders when investing their funds. It is also the bottom line of project’s return when managers make their decisions. It almost affects every aspect of a firm including its capital structure, profits, management and so on. It is well known that the existence of information asymmetry will rise up both information problem and agency problem. Both problems could impede the efficient allocation of resources in a capital market economy by imposing investor with great information risk. As a result, it may raise the firm’s cost of equity capital thus undervalue some good ideas in the capital market. Because of its importance, there are significant regulations governing corporate reporting and disclosure in all countries around the world. From2012, all publicly listed companies are required to not only disclosure its self-assessment internal control report but also issue audited reports on the self-assessment report. It marked the internal control information discourse in China is going into the mandatory disclosure stage. Since internal control is related to managing business risk and includes controls with an operational nature, it could provide investor with significantly useful information. Before the mandatory disclosure stage, identifying whether voluntary internal control information disclosure could mitigate information asymmetric and thus decrease firm’s cost of equity capital is of great necessity, it could also implicated to the future internal control information disclosure in the mandatory stage.This paper estimates the cost of equity by using PEG model (Easton,2004), which is based on the residue income model and use the implied cost of capital as a proxy of cost of equity capital. Voluntary internal control disclosure contains two aspects, only disclosure self-assessment internal control report (only self-evaluated the effectiveness of internal control) and disclosure both self-assessment and assurance internal control report (not only self-evaluated but also external auditor-assessed the effectiveness of internal control). When using PEG model estimates the implied cost of capital, the analysts forecast of the firms earning is of great imports to the accuracy of estimation. For the firm with high analysts following, it is more likely the analysts could consider more factors regarding internal control and its voluntary disclosure. As a result, the forecasted earning of the high analysts following firm should be more consisted with the real economic earning. Thus, the paper continues to divide the sample into two groups, high analysts following group and low analysts following group. Then study the relationship of the voluntary internal control information disclosure and cost of equity capital. It finds that in the high analysts following group, the cost of equity capital of the firm disclosure both self-assessment and assurance internal control report is significantly decrease than other firms. There is no significantly different between the firm disclosure only self-assessment internal control reports than other firms. However, within the low analysts following group, no relationship between the cost of equity capital and voluntarily internal control information disclosure is found. It may be because of the analyst forecast of firms future earning in high analyst following group is more accurate regarding to its economic earrings because of taking into more consideration of factors of internal control and its voluntary disclosure than low analyst following group, and as a result the estimated implied cost of return in high analyst following group is more similar to the real cost of equity capital. To conclude, after considering the accuracy of analysts forecast and dividing the sample into high analyst following group and low analyst following group, this paper find voluntary disclosure of internal control assurance report can decrease the firm’s cost of equity capital, however voluntary disclosure of internal control self-assessment report cannot decrease the firm’s cost of equity capital.