Cost of capital and earnings transparency

We provide evidence that firms with more transparent earnings enjoy a lower cost of capital. We base our earnings transparency measure on the extent to which earnings and change in earnings covary contemporaneously with returns. We find a significant negative relation between our transparency measure and subsequent excess and portfolio mean returns, and expected cost of capital, even after controlling for previously documented determinants of cost of capital.

► Our study is the first to establish a significant negative relation between earnings transparency and cost of capital. ► Our transparency measure is based on the extent to which earnings and change in earnings covary with stock returns. ► Our transparency measure permits cross-sectional and intertemporal variation in the returns-earnings relation. ► Firms with more transparent earnings have lower cost of capital as reflected in subsequent excess and portfolio mean returns ► More transparent earnings also are significantly negatively associated with expected cost of capital.