The relationship between earnings quality and the cost of equity in China

Abstract

This paper examines the relationship between earnings quality and the cost of equity in China under China's accounting system based on 2757 public firms from 1999 to 2015. Accruals quality and earnings persistence are two primary attributes of earnings quality to test the relationship. By following Dechow and Dechive's (2002) model, my findings show that accruals quality is negatively correlated with the cost of equity, and earnings persistence is positively correlated with the cost of equity. Besides, my results also indicate a stronger impact of accruals quality on the cost of equity compared to persistence. Therefore, earnings quality is negatively correlated with the cost of equity. Earnings-increasing discretionary accruals have a significant positive impact on the cost of equity, which shows a higher return to investors when firms adopt opportunistic earnings management. However, informative management leads to less cost of equity compared to opportunistic management.