Voluntary Disclosure and the Cost of Capital: Evidence from Management Earnings Forecasts

Abstract

This paper examines the effect of management earnings forecasts on the cost of capital. We find that forecasters of bad news experience a significant increase in the cost of capital in the month after their disclosure. Conversely, the cost of capital for good news forecasters declines mildly in the same period. We also indicate that bad news forecasts are more informative by comparing the absolute value changes in the cost of capital between bad and good news firms. In addition, we find no significant relation between forecast precision and the cost of capital. Finally, we examine the combined effects of the management earnings forecasts and the earnings announcement on the changes in the cost of capital. Consistent with prior studies, we show that the effect of the subsequent earnings announcement is preempted by the management forecasts for bad news firms, but not for good news firms.

Keywords: Management earnings forecasts, the cost of capital, bad news, good news, and the earnings announcement.