Cost Of Equity Financing Research Articles

Disentangling Value: Misvaluation and Divestitures

This paper presents a rationale for divestiture consistent with one of the frequently cited reasons by divesting firms, namely, that the firm is undervalued and splitting the firm into its component businesses will make it easier for the market to value the components accurately. The rationale is based on two basic premises. One, the market can observe the aggregate cash flows of the firm but not divisional cash flows; two, the cost of financing a project by divesting a division is greater than the cost of external equity financing which, in turn, is costlier than internal capital. In this setup, we show that the firm may be misvalued if the informativeness of divisional cash flows regarding the respective divisions' future prospects are different. If an undervalued firm needs external capital, it may resort to costly divestiture while an overvalued firm will use less costly external equity, resulting in correct valuation of the divisions. Among the empirical implications the model yields are: 1) The stock price reaction to a divestiture announcement is positive and is greater for focus-increasing divestitures; 2) Firms that divest invest more than their conglomerate counterparts; 3) Firms that divest are likely to divest the poorly performing divisions.

LIFE CYCLE COSTING AND THE DESIGN OF STRUCTURES WITH PARTICULAR REFERENCE TO BRIDGES.

This paper discusses the use of Life Cycle Costing (LCC) as part of the general design process for structures. It explains the basic principles of LCC. It considers the incidence of defects in Britain's bridge stock which is considered by the authors of this paper to be significantly higher than many authorities acknowledge. Average repair costs for bridges are suggested and the critical importance of traffic delay costs to the application of LCC to bridge is emphasized. Historical data in relation to the true cost of loan and equity finance are presented, and appropriate discount rates for various types of organization, including the effects of inflation, are discussed. Examples of radical design decisions that could potentially be justified using LCC are presented, as is the view that the widespread application of LCC in the design process is needed if a correct appraisal of future maintenance costs is to be made. It is then suggested that this would result in significant improvements in both design and maintenance practices. (A)

Size, Liquidity, and the Cost of Equity

The inverse association of capitalization and performance is found to hold over a broader range of firms than has been previously studied. This result is found by merging data for listed United States firms with data for listed Australian companies, which are on average much smaller than their North American brethren. For the entire size spectrum and across listing locations, liquidity is found to be related to performance, adding support to the popular belief that it is (perhaps one of) the factor(s) missing from conventional tests of asset pricing. The results suggest that a lack of liquidity, rather than size per se, is a material contributor to the high cost of equity finance experienced by small companies. Some commentators attach much currency to proposals to subsidize small firms by enhancing the liquidity of their shares; the results reported here suggest that such subsidies may be effective.

The vanishing harberger triangle

This paper shows that the double taxation of corporate dividends (or profit repatriations) implies a nucleus theory of the corporation. After the firm is set up with a small stock of original capital, it enters a phase of purely internal growth during which no dividends are paid and no shares are issued. The phase terminates when an efficient stock of capital has been accumulated and dividends are paid. During the growth phases, the tax distortion is inversely related to the tax burden and it is larger than conventional formulae for the cost of internal and external equity finance suggest.