The impact of earnings quality on aspects of capital markets: evidence from UK listed firms

Abstract

This thesis investigates the association between four accounting-based earnings quality proxies and three capital market aspects of UK listed firms after applying the International Financial Reporting Standards (IFRS). The three capital market aspects are: the cost of equity capital; information symmetry; and analysts’ information environment (number of analysts following, the dispersion of analysts’ forecasts and the accuracy of analysts’ forecasts). It finds evidences that firms with low earnings quality have a higher cost of equity capital, higher information asymmetry, lower number of analysts following, a higher dispersion of analysts’ forecasts and less accurate analysts’ forecasts than firms with high earnings quality. Also, the results show that the innate component of each earnings quality proxy, driven by economic fundamentals, has a larger impact on the three aspects of capital market than the discretionary component, driven by management choices. This is consistent with the theoretical framework of IFRS which the UK adopted in 2005 for listed firms. These findings shed light on the important role of earnings quality in helping analysts and investors to make better financial investment decisions. Theory suggests that this role is achieved by increasing the informativeness of firms’ information environment, improving the precision of financial information, reducing estimation risk and information asymmetry; these are expected to lead to a lower cost of equity capital.