Expected Earnings Growth and the Cost of Capital: An Analysis of Accounting Regime Change in the European Financial Market
33 Pages Posted: 15 Jun 2006
Date Written: April 2006
Abstract
This study focuses on the relation between the cost of equity capital and earnings expectations when the properties of accounting that determine earnings vary across different regulatory regimes. More particularly, it addresses the European setting where different types of GAAP regime have continued to function in the presence of the gradual harmonization of the underlying legal framework, and where the adoption of internationally recognised accounting standards by certain firms has anticipated the requirement for International Financial Reporting Standards. On the basis of estimates of the cost of equity that are implied by analysts' earnings forecasts, the paper provides evidence that financial market integration may have already contributed to mitigating the economic consequences of accounting diversity, and that switching to IFRS could have a short lived impact on capital markets. Moreover, based on firm level transparency and disclosure rankings provided by Standard and Poor's, it is shown how the quality of financial reporting conditions the implied cost of equity under different GAAP.
Keywords: Abnormal earnings growth, Analysts' forecasts, Cost of capital, Harmonization, International financial reporting standards, Transparency and disclosure
JEL Classification: M41
Suggested Citation: Suggested Citation
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