||The Effects of Geographic Diversification and Earning Quality on the Cost of Equity Capital
||Graduate Institute of Finance
Cost of Equity Capital
This paper investigates the effect of geographic diversification and information transparency on the cost of equity capital for multinational companies. The data used in this study are from the DataStream and the I/B/E/S databases. After merging all the variables and eliminating any abnormal values, we ultimately have 955 observations from 2002 to 2014 globally.
The results indicate that geographic diversification will increase the cost of equity capital for multinational companies due to the fact that the benefits of diversification are less than the potential costs. However, this also provides a guideline or reference for companies because more comprehensive planning might be necessary for a company applying a diversification strategy. Because the widely used accounting standards from US GAAP are now being replaced by the International Financial Reporting Standards (IFRS), this research takes earning quality as a moderator to smooth the potential risks and the losses of implementing diversification, which also is intended to serve as guideline for corporations who have been practiced diversification or are planning diversification strategy.
We utilize the accruals quality model and the discretionary accruals model to investigate if a higher degree of earnings quality can reduce the cost of equity capital. The results of the discretionary accruals model shows that firms providing higher quality reported earnings will enjoy relatively lower cost of equity capital. Then, we take geographic diversification, earnings quality and cost of equity capital into consideration to further examine the relationships among them. The results indicate that geographic diversification of multinationals with complicated corporate organizational structures can moderate their cost of equity capital through promoting the trust of investors in their company's reported earnings and forecast information, which is achieved by enhancing the quality of reported earnings.
Chapter 1 Introduction 1
1.1 Research Background and Motivations 1
1.2 Research Objectives 3
1.3 Research Contributions 4
1.4 Research Framework 4
Chapter 2 Literature Review and Hypothesis Development 7
2.1 The Motives and Benefits of Diversification 7
2.2 The Costs of Diversification 10
2.3 Information Disclosure and the Cost of Capital 12
2.4 Earning Quality and the Cost of Capital 13
2.5 Hypotheses Development 15
Chapter 3 Data and Methodology 20
3.1 Sample Selection and Description 20
3.2 The Measurement of Implied Cost of Equity Capital 21
3.3 The Measurement of Geographic Diversification 26
3.4 The Measurement of Earning Quality 27
3.5 Control Variables Selection 30
3.6 Empirical Model 33
Chapter 4 Empirical Results 36
Chapter 5 Conclusions 49
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