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Innovation disclosure and the cost of capital – UK-based evidence

Matthews, L. (2019) Innovation disclosure and the cost of capital – UK-based evidence. PhD thesis, University of Reading

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Abstract/Summary

This study examines the economic effects of innovation disclosure in the annual reports of UK listed firms. Two overarching research questions are posed: first, to examine whether the levels of innovation disclosure are negatively associated with the cost of capital; and second, to examine the presence of proprietary costs (e.g. competition pressure proxied by the HH Index) for moderating effects on the association between innovation disclosure and the cost of capital. Two distinct types of innovation are recognized: exploration and exploitation. Both types of innovation disclosure are examined independently and combined. The dictionary tool of (Heyden et al. 2015: xvii) is adapted to identify exploration and exploitation disclosures through computer-aided textual analysis (CATA). The two components of the cost of capital are considered: the implied cost of equity capital and the after-tax cost of debt capital. Using a longitudinal unbalanced panel dataset of FTSE 350 firms for the period 2011-2016, a number of findings are documented. First, evidence shows that firms with R&D expenditure, high analyst-followings, large market capitalization and new issues of financing tend to have more combined disclosure levels than do firms with non-R&D expenditure, low analyst-followings, small market capitalization, and no new financings, respectively. Second, firms on average disclose more exploration than exploitation innovation, although the bulk of benefits across the full sample (i.e. reductions in the cost of equity capital and the after-tax cost of debt capital) arise from exploitation rather than from exploration disclosure. Third, in a notable exception, R&D firms experience significant reductions in the cost of equity capital from exploration disclosure, but no significant reductions in the after-tax cost of debt capital from any of the disclosures. Interestingly, R&D firms show the highest synergic benefit in the cost of equity capital from the combined disclosure. Non-R&D firms, however, enjoy significant reductions in the cost of equity capital and the after-tax cost of debt capital from exploitation disclosure. Fourth, firms with high analyst-followings enjoy significant reductions in the cost of equity capital and the after-tax cost of debt capital from exploitation and combined disclosures. Firms with low analyst-followings, however, enjoy significant reductions only in the cost of equity capital from exploitation disclosure. Fifth, large-sized firms earn significant benefits in the cost of equity capital and the after-tax cost of debt capital from exploitation disclosure, while small firms earn significant reductions only in the cost of equity capital from exploitation disclosure. Sixth, firms with newly issued financings benefit only in the cost of equity capital from exploitation and combined disclosures, while firms with no new financings earn significant benefits only in the after-tax cost of debt capital from exploitation disclosure. The seventh finding, regarding the moderating effect of proprietary costs, reveals two contrasting stories depending on the type of cost of capital in question. Consistent with the hypothesis, the evidence from the implied cost of equity capital shows that the benefits of the combined disclosures are weaker in the presence of high proprietary costs. For the after-tax cost of debt capital, a moderating effect of proprietary costs is detected with exploitation rather than the combined disclosure. Unexpectedly, the evidence from the after-tax cost of debt capital shows that the benefits of exploitation disclosure are stronger in the presence of high proprietary costs. Due to the inherently problematic nature of the implied cost of equity capital, a number of alternative measures were adopted, including the CAPM estimates of the cost of equity capital, stock returns volatility, liquidity metrics for the average of closing bid-ask spread percentages and the ratio of closing trading volume to the outstanding number of common shares and, finally, the accuracy of analyst forecasts. Findings from these alternative measures are qualitatively similar to those from the implied cost of equity capital, reaffirming the beneficial effects of innovation disclosure. This work contributes to a number of fields as it integrates accounting research with a stream of organizational and management literatures. The first contribution is the introduction of a new typology of recognizing and measuring innovation disclosure; that is novel to accounting but well established in other organizational and management studies. Second, it contributes with evidence that the disclosure of exploration and exploitation innovation are of economic relevance and have significant effects in reducing information asymmetry. Finally, this study contributes vital evidence regarding the moderating effects of proprietary costs on the association of innovation disclosure and the cost of capital.

Item Type:Thesis (PhD)
Thesis Supervisor:Stenka, R. and Yang, J.
Thesis/Report Department:Henley Business School
Identification Number/DOI:
Divisions:Henley Business School > Business Informatics, Systems and Accounting
ID Code:84936

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