Question #3

In a recent study, Artiach and Clarkson (2014) examine the joint impact of conservatism and disclosure on the cost of equity capital. Their study comprises the following three primary hypotheses:

H1: Firm level conservatism is inversely related with the cost of equity capital.

H2: Firm level disclosure is inversely related with the cost of equity capital.

H3: The nature of the relationship between firm level conservatism and the cost of equity capital is conditional on the level of information asymmetry (disclosure).

In developing the third hypothesis (H3), they argue that the impact of conservatism on cost of equity capital is likely diminished (weakened) when there is low information asymmetry (high disclosure) because in such a setting, all market participants already have access to considerable public information and thereby the role of conservative accounting is largely redundant.

A modified subset of the data used in the study can be found in the file ‘6923.Q3(20-2).xls’. The data cover 1,782 firm-years. The measures included in the file are as follows:

COEC = the firm’s cost of equity capital;

CONSV         = the firm’s conservatism measure; and

DISCL = the firm’s disclosure measure.

In each instance, higher values denote higher values of the measure (e.g., higher cost of equity capital, more conservative, greater disclosure).

Required:

(a) Present a single regression model involving the measures identified above which can be used to test all three of Artiach and Clarkson’s hypotheses within this single model. For this model, explain which coefficient is the relevant one to test each hypothesis and what its predicted sign is.

(b) Using the data identified above, estimate your proposed regression model. Based on your regression output, do the data support the predictions that Artiach and Clarkson make? In your answer, you should explain your conclusions in terms of the statistical significance and plausibility of the coefficients.