Insider trading laws, earnings management and the cost of equity capital

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Insider trading laws, earnings management and the cost of equity capital

 

Author: Lo, Ping-wa Lawrence
Title: Insider trading laws, earnings management and the cost of equity capital
Degree: D.B.A.
Year: 2008
Subject: Hong Kong Polytechnic University -- Dissertations.
Insider trading in securities -- Law and legislation.
Corporate profits.
Capital investments.
Department: Graduate School of Business
Pages: vi, 157 leaves ; 30 cm.
Language: English
InnoPac Record: http://library.polyu.edu.hk/record=b2241459
URI: http://theses.lib.polyu.edu.hk/handle/200/3951
Abstract: International differences in firms' cost of capital can be affected by investor protection at country level. Recent studies on insider trading law suggest that the existence and enforcement of these investor protection securities laws can reduce the cost of capital. This paper attempts to examine the association between insider trading law enactment and enforcement, earnings management and the cost of equity capital across 18 developed and 13 emerging markets outside North America between 1990 and 2005. The first objective of my paper is to examine whether the existence of investor protection law lowers the cost of equity. Secondly, it investigates whether insider trading law establishment and /or enforcement reduces a firm's cost of equity. Insider trading law enforcement is split into public and private enforcement. I analyze the impact of public enforcement of insider trading law and the effect of private enforcement on the cost of equity separately. Thirdly, I investigate whether insider trading law enforcement and earnings management increase the cost of equity. Fourthly, I consider whether insider trading law enforcement is more important in emerging markets than in developed ones. I have used five different cost of equity measures to test my hypotheses. The results of my regression analysis are consistent with my expectations and previous literature and strongly support my hypotheses. Firstly, the mere establishment of insider trading laws cannot reduce the cost of equity capital (HI). Secondly, the enforcement of insider trading laws has no effect on the cost of equity (H2). Thirdly, effective public enforcement of securities laws can lower the cost of equity (H3). Fourthly, private enforcement of securities laws can reduce the cost of equity capital (H4). Lastly, enforcement of insider trading laws is more important in emerging markets than in developed markets (H5). I carry out some additional tests to examine how the enactment or enforcement of insider trading laws interplay with public or private enforcement power in determining the cost of equity. Firstly, it lends support to the previous findings and confirms my hypotheses HI, H2, H3 and H4. Secondly, it shows that even with the help of strong public and private enforcement power, the mere establishment of insider trading laws is not effective in reducing the cost of equity. Thirdly, there is some evidence that after insider trading laws have been enforced in a given country, private enforcement power is more effective than public enforcement power in reducing the cost of equity. Finally, while earnings smoothing can reduce the cost of equity, there is no obvious conclusion for earnings discretion in the context of earnings management.

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