This dissertation, "The Effect of Earnings Quality on the Association Between Information Precision and the Cost of Equity Capital" by Jia, Zhu, 朱佳, was obtained from The University of Hong Kong (Pokfulam, Hong Kong) and is being sold pursuant to Creative Commons: Attribution 3.0 Hong Kong License. The content of this dissertation has not been altered in any way. We have altered the formatting in order to facilitate the ease of printing and reading of the dissertation. All rights not granted by the above license are retained by the author. Abstract: Abstract of thesis entitled The Effect of Earnings Quality on the Association between Information Precision and the Cost of Equity Capital Submitted by Zhu Jia For the Degree of Master of Philosophy At the University of Hong Kong In March 2007 Abstract A growing volume of literature on the association between information and the cost of equity capital has investigated various firm-specific factors that may affect the relationship between public disclosure and the cost of equity capital. My empirical study adds to this literature by showing that the earnings quality of firms might also play a determining role in the association between public information precision and the cost of equity capital. The earnings quality indicator in this study is used to proxy the value-relevance of public disclosure and is included as a control variable in the regression of the cost of equity capital estimates on the information precision. I document that public information is in general negatively associated with the cost of equity capital. However, when the earnings quality of firms is deteriorating to certain extent, the cost of equity capital goes up in response to more precise public information. Moreover, I find that the public and private information precisions act as complements. On the other hand, I do not find an unambiguous association between private information precision and the cost of equity capital, nor any reliable evidence about the direct impact of the earnings quality indicator on the cost of equity capital. (No. of words: 201) DOI: 10.5353/th_b3879143 Subjects: Corporate profits Disclosure of information Capital costs

This review lays out a research perspective on earnings quality. We provide an overview of alternative definitions and measures of earnings quality and a discussion of research design choices encountered in earnings quality research. Throughout, we focus on a capital markets setting, as opposed, for example, to a contracting or stewardship setting. Our reason for this choice stems from the view that the capital market uses of accounting information are fundamental, in the sense of providing a basis for other uses, such as stewardship. Because resource allocations are ex ante decisions while contracting/stewardship assessments are ex post evaluations of outcomes, evidence on whether, how and to what degree earnings quality influences capital market resource allocation decisions is fundamental to understanding why and how accounting matters to investors and others, including those charged with stewardship responsibilities. Demonstrating a link between earnings quality and, for example, the costs of equity and debt capital implies a basic economic role in capital allocation decisions for accounting information; this role has only recently been documented in the accounting literature. We focus on how the precision of financial information in capturing one or more underlying valuation-relevant constructs affects the assessment and use of that information by capital market participants. We emphasize that the choice of constructs to be measured is typically contextual. Our main focus is on the precision of earnings, which we view as a summary indicator of the overall quality of financial reporting. Our intent in discussing research that evaluates the capital market effects of earnings quality is both to stimulate further research in this area and to encourage research on related topics, including, for example, the role of earnings quality in contracting and stewardship.

Prior studies report negative or insignificant relations between conditional conservatism and the cost of equity capital, arguing that conservatism reduces information risk. Using accounting-based conditional conservatism proxies, however, we find a significantly positive association between conditional conservatism and the cost of equity. This positive relation operates via improving information precision about negative earnings shocks and generally inflating information asymmetry among investors, both of which increase the cost of equity. We further find that the cost of equity effect of conditional conservatism disappears in the period after the enactment of the Sarbanes-Oxley Act (SOX), consistent with the notion that nationwide improvement of information precision about negative news and diminished information asymmetry are engendered by the SOX regulation. This study adds to researches on conditional conservatism, SOX, and the cost of equity, and also has policy implications.

The accounting scientific literature pays much attention focusing on the incentives of the use of earnings management. The purpose of this study is to explore the relationship between Earning management and cost of equity capital in 150 Malaysian firms over the period 2000-2011. The main objective of this research is that whether or not firms manage earnings to profit from a lower cost of capital. The library method is used for gathering information and the method of multiple regressions has been used to predict this relation. To determine cost of equity growth (Gordon) model has been used, and adjusted model of Jones has been used to determine of earning management. Debt to equity ratio, firm size and return on equity were used as control variable. In general, findings from the empirical analysis indicate that the relationships between cost of equity and earning management was inverse but weak, and all control variable have significant relation with cost of equity except return on equity.

The purpose of this thesis is twofold. First it empirically examines the association between the level of undervaluation of a firm's equity and three information risk proxies including earnings quality, analysts following and dispersion of analysts' forecasts. Second, given that earnings quality has implications for equity pricing; the thesis examines the association between the level of equity undervaluation and earnings quality in the year post-undervaluation. The empirical evidence provided for the first test clearly indicates that lower earning quality, fewer analysts following and higher dispersion of analysts' forecast are having a significant and negative impact on the level of equity undervaluation. This is consistent with the proposition that investors are expected to be willing to pay less for a stock that is perceived to have higher information risk, due to increased information asymmetry and agency costs. Unlike the existing literature, these findings indicate that investors price earnings quality, proxied by the absolute magnitude of abnormal accruals, and they are not fooled by reporting higher levels of earnings, as a result of greater earnings management practices. In addition, the empirical findings provided for the second test suggest that greater improvement in earnings quality in the current year (reduction in earnings management practices) is explained by the higher level of equity undervaluation in the preceding year. This result is consistent with the notion that managers of undervalued firms will subsequently improve earnings quality as a signaling mechanism to reduce information risk and change the investors' perception of their firm's equity value. Additional tests compare the results of undervalued sample with the results of a control sample (non-undervalued sample), and suggest that the managerial tendency to improve earnings quality in the following year is unique only to undervalued sample. Additional tests were also conducted to capture the impact of the Sarbanes-Oxley Act (SOX) on the final results. Fundamentally, this thesis suggests that higher information risk is expected to provide a tangible detriment for managers in the form of lower equity valuation. In order to mitigate information risk associated with lower earnings quality, the managers of undervalued firms should utilize their discretion over accounting accruals to improve earnings quality, and therefore change investors' perceptions of their equity value.