Two essays on stock market consequence of earnings quality

Abstract

This dissertation investigates whether earnings quality affects firm's cost of equity or expected stock returns. The first essay extends prior U.S. studies to examine whether the association between earning quality and cost of capital exists in emerging markets. Specifically, the first essay investigates whether earnings quality affects a firm's cost of equity capital in the Chinese stock market, one of the world's largest and fastest growing emerging markets. Measuring earnings quality as unsigned abnormal accruals and unsigned abnormal non-operating earnings, I find that higher quality of earnings is associated with lower cost of equity in the China's stock market, based on a large sample of partially privatized firms during the period of 1994-2004. In addition, I find that the enacting of the Securities Law of China in 1999 enhances the association between earnings quality and cost of equity capital. This might imply that Securities Laws promote higher level of legal protection, which makes it a more effective way to lower cost of financing by increasing earnings quality.