Disclosure and the Cost of Capital: Evidence from Firms' Responses to the Enron Shock

66 Pages Posted: 20 Apr 2009 Last revised: 16 Sep 2022

See all articles by Christian Leuz

Christian Leuz

University of Chicago - Booth School of Business; National Bureau of Economic Research (NBER); Centre for Economic Policy Research (CEPR); European Corporate Governance Institute (ECGI); Leibniz Institute SAFE; CESifo Research Network; Center for Financial Studies (CFS)

Catherine M. Schrand

University of Pennsylvania - Accounting Department

Date Written: April 2009

Abstract

This paper examines the link between disclosure and the cost of capital. We exploit an exogenous cost of capital shock created by the Enron scandal in Fall 2001 and analyze firms' disclosure responses to this shock. These tests are opposite to the typical research design that analyzes cost of capital responses to disclosure changes. In reversing the tests and using an exogenous shock, we mitigate concerns about omitted variables in traditional cross-sectional disclosure studies. We estimate shocks to firms' betas around the Enron events and the ensuing transparency crisis. Our analysis shows that these beta shocks are associated with increased disclosure. Firms expand the number of pages of their annual 10-K filings, notably the sections containing the financial statements and footnotes. The increase in disclosure is particularly pronounced for firms that have positive cost of capital shocks and larger financing needs. We also find that firms respond with additional interim disclosures (e.g., 8-K filings) and that these disclosures are complementary to the 10-K disclosures. Finally, we show that firms' disclosure responses reduce firms' costs of capital and hence the impact of the transparency crisis.

Suggested Citation

Leuz, Christian and Schrand, Catherine M., Disclosure and the Cost of Capital: Evidence from Firms' Responses to the Enron Shock (April 2009). NBER Working Paper No. w14897, Available at SSRN: https://ssrn.com/abstract=1391844

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