Disclosure, Corporate Governance, and the Cost of Equity Capital in Emerging Markets

This study examines the effects of firm-level disclosure and corporate governance on the cost of equity capital in emerging markets through two newly released surveys from Credit Lyonnais Securities Asia (CLSA). When we do not include book-to-market ratio and corporate governance as control variables following the practice in previous studies (e.g., Botosan and Plumlee 2002 and Francis, Khurana, and Pereira 2003), we find that disclosure can significantly lower the cost of equity in emerging markets, and that this effect is observed only in countries that protect investors relatively well. Thus, firm-level disclosure and country-level legal protection seem to play a complementary role in reducing a firm's cost of equity. However, this effect becomes insignificant after controlling for the effect of book-to-market or corporate governance; i.e., the disclosure effect is subsumed by the effect of book-to-market or corporate governance. In contrast, we find that corporate governance always has a significantly negative effect on the cost of equity capital under various regression specifications. In addition, this effect is significant only in countries that provide relatively poor legal protection for investors. That is, firm-level corporate governance and country-level legal protection seem to play a substitute role in reducing the cost of equity. Overall, our findings suggest that in emerging markets in which the legal protection of investors is lacking, firms that wish to reduce their external financing costs should strengthen their corporate governance mechanisms, rather than adopt more forthright disclosure policies as the priority.