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Abstract

The effect of earnings quality on firm value is examined and whether the cost of capital is a mechanism that provides economic linkages between earnings quality and corporate valuation is tested.
The study uses archival panel data for 40 non-financial companies, which are listed on the Iraq Stock Exchange, in the four sectors of industry, hotels and tourism, agriculture, and telecommunication. The performance-matched discretionary accrual is used as the measure of earnings quality, Tobin's Q as a measure of firm value and the weighted average cost of capital (WACC) as a measure of cost of capital. The hypotheses are tested using regressions with fixed-effects of firms and year and firm-cluster bootstrap mediation analysis.
The results indicate that higher earnings quality is associated with higher firm value and a lower cost of capital. The relationship between earnings quality and firm valuation is negatively related with the cost of capital, and the cost of capital partially mediates the relationship between earnings quality and valuation. The results are consistent across a variety of alternative proxies for earnings quality, financing costs, and firm value.
The data comes from a relatively small niche emerging capital market, and thus must be interpreted with some caution. Comparing these results with larger regional samples and other mediating mechanisms could be a topic for further research.
The results indicate that credible earnings are economically beneficial because they can diminish information risk, reduce costs of financing and enhance the valuation of the market.
The study brings together three separate studies (earnings quality and firm value, earnings quality and financing costs, financing costs and firm value) and evidence from an under-researched emerging market, in all one mediation model.

Keywords

Earnings quality, Firm value, Cost of capital, Information asymmetry, Financial reporting quality

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