PEER FIRM EARNINGS QUALITY AND THE COST OF EQUITY

Abstract

This study examines how a firm’s cost of equity is affected by industry peer firms’ earnings quality. First, using Lambert, Leuz and Verrecchia (2007) as a theoretical basis, I predict and provide evidence that higher industry peer firms’ earnings quality reduces a firm’s cost of equity via the systematic market risk. Second, the negative association is more pronounced for the subsample with high industry peer earnings quality. Third, the cost of equity effect of industry peer firm earnings quality is mitigated by multinational operations and higher profitability relative to industry peers. These findings are consistent with the theory that industry peer firms’ earnings quality changes the cost of equity by affecting investors’ assessed covariance of the firm’s expected future cash flows with that of other firms. Overall, my study contributes to a better understanding of the capital market consequences of financial information quality.