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The relationship between earnings quality and the cost of equity capital - Evidence from the Netherlands in the period 2012-2016

Hees, P.F.M. van (2019) The relationship between earnings quality and the cost of equity capital - Evidence from the Netherlands in the period 2012-2016.

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Abstract:For companies to operate and expand it is important to have access to capital. Capital can be obtained in the form of debt or equity. For capital providers, dispensing capital in either form – debt or equity – means a commitment to a certain level of risk. This risk is compensated for with a risk premium. This risk premium is a cost of companies obtaining capital. Therefore, for companies to obtain capital at the lowest possible cost, the risk premium needs to be brought to a minimum. Prior literature offers many factors that influence the cost of capital. This research tests earnings quality and firm performance as factors that influence the cost of equity capital. Cost of equity capital was measured using the Capital Asset Pricing Model (CAPM), earnings quality was measured using a natural logarithm of discretionary accruals as a proxy, and firm performance was measured using the lagged return on equity ratio. The relationships between earnings quality and cost of equity and firm performance were tested using a sample of 61 Dutch listed firms over a 5-year time period, resulting in 305 firm-year observations. Using OLS regression models, the outcomes of this research show that, contrary to prior literature, there is no significant relationship between earnings quality and the cost of equity capital, nor do the results show that firm performance significantly lowers the cost of equity. There are several potential explanations as to why this research finds contrasting results. The first being the data that is used. This research limits the data to the Dutch market only and leaves out certain companies that rely heavily on regulation. On the Dutch stock-market these are the majority. Secondly, this research limits the calculation of earnings quality to the CAPM. This model has known limitations, which are discussed. Other studies have primarily used different measurement models. Lastly, this study has used only one measurement for earnings quality, being the natural logarithm of discretionary accruals.
Item Type:Essay (Master)
Faculty:BMS: Behavioural, Management and Social Sciences
Subject:83 economics, 85 business administration, organizational science
Programme:Business Administration MSc (60644)
Link to this item:http://purl.utwente.nl/essays/81578
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