A Survey of External and Internal Factors Influencing the Cost of Equity: The Case of Czech Companies

Natalia Mokhova,Marek Zinecker

doi:10.5755/j01.ee.30.2.19221

Abstract

The cost of equity is an essential element of a business' financial decision-making process, which is exposed to the influence of a number of internal and external factors. This study intends to answer the question on what is the perceived impact of external and internal factors on the cost of equity from the perspective of Czech CFOs. The survey was carried out in 2015 and our sample covers 40 respondents operating in large and non-financial joint-stock companies. The findings show that there is a gap between the theory and practice and that the country’s specifics, in particular the low level of the financial market development, play a significant role in the perception of cost of equity capital determinants. First, the most commonly used cost of equity estimation approach is based on average historical returns. This method has been indicated by the CFOs across all firms. A considerably large number of the CFOs think that the ownership structure, dividend policy, ability to forecast financial results, stability of company´s earnings and flexibility in external capital raising are the internal factors with the most significant impact on the cost of equity. Otherwise, a rather low number of respondents consider the information asymmetry, corporate governance and financial performance as having a strong impact on the cost of equity, although several financial theories emphasize the role of these internal determinants. In regard to the external factors, a substantial majority of the respondents acknowledges that the long- and short-term interest rates as well as inflation, sovereign debt and risks linked to the banking system and financial market strongly affect the cost of equity. The responses are, however, unambiguous concerning the direction of such an impact. Our results indicate a significant gap between the theoretical approaches and system-relevant knowledge and experience on the side of respondents. We believe that our findings provide valuable implications for companies, banks, stock exchanges and macroeconomic policy makers while formulating new strategies in the specific environment of the Central and Eastern European countries. DOI: http://dx.doi.org/10.5755/j01.ee.30.2.19221

Highlights

IntroductionThe cost of equity capital (hereinafter only as the “CEC”) is an essential part of business decision-making process
The cost of equity capital is an essential part of business decision-making process
The purpose of this study is to survey a sample of chief financial officers (CFOs) covering large and non-financial common stock companies operating in the Czech Republic to answer the question on how they perceive influence of external and internal factors described in previous academic literature on the CEC

Summary

Introduction

The cost of equity capital (hereinafter only as the “CEC”) is an essential part of business decision-making process. There are many academic theories on the CEC focusing on different approaches to its measurement, adjustment, and management. These theories have been predominantly developed in the conditions of well-developed economies of Western Europe and the USA since the 1950s. There are just a few surveys on the topic enabling to identify factors that may have significant impact on the financial decision making in the Central and Eastern European (CEE) countries, which are assumed to differ from well-developed EUs markets in terms of their riskiness and return characteristics (Lizińska & Czapiewski, 2016), and which are characterized even twenty years in post-transformation period by underdeveloped national capital markets (Berk & Peterle, 2016; Lyócsa 2014). An important role is played by the ownership structure of companies operating in the Czech Republic: Foreign parent companies represent a massive influx of capital and decisions on capital structure are made at headquarters level abroad

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