Financial analysts' actions and cost of equity capital

Abstract

This paper examines the relationship between financial analysts' actions and cost of equity capital. In this study, financial analysts' actions include analysts' forecasts dispersion, analysts' forecast revision frequencies and analysts' responsiveness to quarterly earnings announcements. There are empirical studies that attempt to find out the variables that are associated with firm’s cost of equity capital. One research study finds that poorer accruals quality is associated with larger costs of capital. However, a more recent empirical study shows no evidence that accruals quality and costs of equity capital are associated. As such, the link between accounting accruals quality and cost of equity capital has not been conclusively established under empirical tests. Instead of looking at firm specific accounting information that managers of firms want to signal to market participants, i.e., accounting accruals quality, this study attempts to find out the relationship between financial analysts' actions, which is exogenous to firms, and cost of equity capital. The empirical results of my study show that firms with larger analysts’ forecasts dispersion, their cost of equity capital is higher. Nevertheless, this relationship is substituted by analysts' responsiveness to quarterly earnings announcements, after controlling for accounting accruals quality, idiosyncratic and systematic risk. Keywords: Accruals quality; Analysts' responsiveness; Analysts' forecasts dispersion; Analysts' forecast revision frequencies; Idiosyncratic risk; Systematic risk; Cost of equity capital