Accounting Information and Cost of Capital: A Theoretical Approach

The primary goal of this study is to provide a theoretical model that shows explicit solutions for equilibrium prices and derives the equilibrium required return for the firm’s stock. In other words, this theoretical study will provide a direct link between accounting information related to the firm’s reports and the cost of capital (so as between the cost of capital and the firm’s stock returns) within an equilibrium setting. Accounting information is judged to be of high value because it affects the market’s ability to direct firms’ capital allocation choices. The findings showed that an increase in expected cash flows, coming from improvements in the quality of accounting information, leads to a reduction in the firm’s cost of capital.