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This study uses sample companies listed in Taiwan Stock Exchange and GreTai Securities Market during 2000 to 2011 to investigate the influence of earnings equality and liquidity on the cost of equity. We define discretionary accruals with three measures and real earnings management with three measures as indicators of earnings quality; trading volume, individual stock liquidity and market liquidity as liquidity measures and individual stock and market liquidity risk as liquidity risk measures. Panel data is suggested for this analysis. Firms manipulating discretionary accruals increase in the cost of equity, but ones operating real earnings management decrease in it when considering that the earnings quality and liquidity directly impact on it. The cost of equity is indirectly influenced by earnings quality and liquidity through information asymmetry measured by bid-ask spreads. The results show that no matter firms engaging in discretionary accruals or real earnings can decrease the cost of equity under higher levels of information asymmetry. The higher the trading volume or the individual stock liquidity risk, the lower the cost of equity when information asymmetry is low.

The Influence of Earnings Quality and Liquidity on the Cost of Equity