Cost of Capital for Exempt Foreign Private Issuers: Information Risk Effect or Earnings Quality Effect? It Depends

We examine whether the information risk accompanying Foreign Private Issuers' (FPIs) exemptions from the U.S. Securities and Exchange Commission (SEC) reporting requirements is associated with capital market penalties (measured by a higher cost of equity capital) and, further, the extent to which this information risk is mitigated by earnings quality. Our overall results indicate that exempt FPIs exhibit a higher cost of equity capital than reporting FPIs, and this relation still persists after controlling for earnings quality. Furthermore, we partition our sample into firms from strong and weak investor protection environments. Interestingly, similar to the results in Francis et al. (2008), for FPIs from strong investor protection regimes we find no difference in the cost of capital between exempt and filing FPIs, even after controlling for earnings quality. To the contrary, for FPIs from weak investor protection regimes, we find that the exemption is associated with a higher cost of equity capital, and that earnings quality does not significantly reduce the premium paid by these issuers.