ELIWA, Y., HASLAM, J. and ABRAHAM, S., 2016. The association between earnings quality and the cost of equity capital: Evidence from the UK. International Review of Financial Analysis, 48, pp. 125–139.
This study examines the association between earnings quality and the cost of
equity in the United Kingdom (UK) over the time period 2005-2011. This setting and time
period enables us to examine the effect of IFRS based earnings on the pricing of earnings
quality and how this relation is influenced by a period of severe macro-economic turbulence
as in the case of the recent global financial crisis. We find a significant negative association
between each accounting-based earnings quality proxy considered separately and the cost of
equity. Our results also indicate that during the financial crisis the relationship between
earnings quality and cost of equity becomes more prominent than in the pre-crisis period.
This strengthening of the relationship during a period of macro-economic turbulence shows
the importance investors place on earnings quality as a measure of risk. Our results also
document that investors place more importance on the innate component of accruals quality
than on the discretionary component. These results should be reassuring to US standard
setters who are considering adopting or converging to IFRS.
This paper was published in the journal International Review of Financial Analysis and the definitive published version is available at http://dx.doi.org/10.1016/j.irfa.2016.09.012.