Cost Of Equity Research Articles

The impact of the stage of the company's life cycle on the cost of equity through the coefficient β

The valuation of the company's equity is one of the main tasks in the framework of the valuation of the company, as well as one of the main sections of corporate finance. The most used method of assessing the return on equity is the CAPM model, but this article analyzes the four-factor Fama-French model- Karcher due to its novelty and, as a consequence, fewer studies. The author analyzes the impact of the company's life cycle on the return on equity using an econometric analysis of 5 clusters of 3,113 public American companies (data for 1989-2019) classified according to the criterion of the stage of the life cycle. The relevance of the study lies in the absence of an unambiguous answer, confirming or refuting the existence of a link between the cost of equity and the stage of the life cycle. The classification is based on an article by Victoria Dickinson, Professor at the University of Mississippi, "Cash flows as an indicator of the stage of the company's life cycle." According to the results, the stage of the life cycle affects the cost of own capital, β the coefficient decreases during the first three stages (formation, growth, maturity), then continues to grow (shake-up, recession). The minimum value falls on the maturity stage, it can be assumed that this stage of the life cycle is the most reliable for stakeholders. This article can be useful to all persons evaluating business (investors, appraisers, etc.), as well as for the further development of this theoretical aspect.

Are Fama–French Factors Relevant? A Sub-Sectorial Analysis

The purpose of the study is to empirically examine the sectoral-specific performance of the five-factor asset pricing model comprising of 17-years’ data in the Indian stock market using the Fama–French methodology. The results highlighted the better performance of a five-factor model in the “Basic Material” and “Oil” industries. However, for the “consumer” industry, there is an existence of other risk factors which can better explain the portfolio’s excess returns. The result further demonstrates the better explanatory power of the five-factor model in explaining the portfolio excess return for the “Industrial” sector. However, the findings support the better applicability of market mode for the “financial” sector in the Indian stock market. For the “Health Care” and “Technology” industries, the addition of two more risk factors does not lead to much improvement in the model’s explanatory power. The current study evaluating the applicability of the asset pricing model will have a practical implication for portfolio managers, policymakers, researchers, and academicians in evaluating the performance of the portfolios on a sectoral basis and in determining the cost of equity in the overall cost of capital. The study will also aid the investors in their investment decision-making by helping them to identify the average stock return in different sectors.

Impact of IFRS 9 on the cost of funding of banks in Europe

On implementation, IFRS 9 increases credit loss (impairment) charges and reduces after-tax profits of banks. This makes retained earnings and hence capital resources lower than what they would be under IAS 39. To maintain their capital ratios under IFRS 9, banks may choose to hold higher levels of equity capital. This paper uses a modified version of CAPM, which accounts for the low-risk anomaly (as suggested by Baker and Wurgler (Baker and Wurgler in American Economic Review 105:315–320, 2015)), to estimate the impact of this potential increase in capital levels on the cost of funding of banks in six European countries, the UK, Germany, France, Italy, Spain and Switzerland. Our results indicate that weak low-risk anomaly exists for banks’ equity in the six countries, except France. The magnitude of the anomaly varies across countries, but is generally low relative to the long-run cost of equity for banks. Due to the weak anomaly, we find a minor “day 1” impact of IFRS 9 on the cost of funding of banks in the six countries.

Does institutional investor cross holding create synergy? Evidence from the cost of equity

We examine the impact of institutional investor cross holding (IICH) on the cost of equity. The findings suggest that IICH firms have a lower cost of equity than non-IICH firms. We find that it is mainly IICH firms in the same industry that successfully reduce their cost of equity. Additional results indicate that IICH investors are more successful at reducing idiosyncratic risk and informational risk and can improve firm performance and governance when they cross hold firms in the same industry. We also find that IICHs with longer tenure, higher competition, and greater analyst following are more successful at reducing the cost of equity.

IFRS 8 and the cost of capital in Europe

AbstractThis study examines segment reporting information usefulness after the adoption of IFRS 8 in 18 European Union countries. Specifically, 1) we introduce a new comprehensive measure of segment reporting quality that reflects four different dimensions of segment information, 2) we investigate the impact of segment reporting quality on the cost of equity and debt capital after the adoption of IFRS 8, and 3) we investigate the moderating role of the country‐level enforcement system on the association between segment reporting quality and the cost of equity and debt capital after the adoption of IFRS 8. Using a self‐constructed segment reporting quality measure and a sample of 884 firm‐year observations over the period of 2007 to 2011, we provide evidence that investors and lending institutions find no change in the usefulness of segment reporting after the adoption of IFRS 8. Our study is original in using a comprehensive measure of segment reporting quality. Furthermore, our study is the first to examine the relationship between segment reporting quality and the cost of debt capital after the adoption of IFRS 8 and the moderating role of the country‐level enforcement system. Our findings provide useful insights to regulator and accounting standard‐setting bodies about segment reporting.

Digitalization of Financial Reporting Through XBRL and the Cost of Equity

This study aims to explore the relation between the pre and post adoption of the Extensible Business Reporting Language (XBRL) adoption and the cost of equity capital in Indonesian-listed firms. The study examines 59 listed companies for four years, including two years before (2014-2015) and two years after (2016-2017) the adoption of XBRL in Indonesia. By comparing the pre and post adoption periods, the multiple regression analysis results will provide valuable information for the related stakeholders of the Indonesia Stock Exchange (IDX). Furthermore, this paper examines the impact of the control variables, such as the firm’s size, leverage, vari-ability of return, and price-to-book ratio to the relationship between XBRL and cost of equity (COE). The results show that XBRL adoption is significant in reducing the cost of equity and large-sized firms are more likely to enjoy greater reduction. This paper contributes to the research area by providing evidence on the relationship between XBRL adoption and COE in Indonesia that have mixed results in various countries and environments.

Corporate social responsibility and systematic risk: international evidence

PurposeThis paper aims to close gaps in the current literature according to whether there are differences regarding the relationship between corporate social performance (CSP) and systematic risk when diverse regions of the world are considered, and what the respective drivers for this relationship are. Furthermore, it tests the robustness to alternative measures for CSP and systematic risk.Design/methodology/approachThis study focuses on the impact of corporate social responsibility on systematic firm risk in an international sample. The authors measure CSP emerging from a company's social responsibility efforts by utilizing a CSP rating framework that covers a variety of dimensions. The instrumental variable approach is applied to mitigate endogeneity and identify causal relationships.FindingsThe impact of overall CSP on systematic risk is most distinct for North American firms and, in descending order, weaker in Europe, Asia–Pacific and Japan. Risk mitigation applies across all four regions. However, the magnitude of impact differs. While the most critical drivers in North America and Japan include product responsibility, Europe is affected most by the employees category and Asia–Pacific by environmental innovation.Practical implicationsThe findings help firms to control their cost of equity and investors may identify low-risk stocks by considering certain aspects of CSP.Originality/valueThis study distinguishes itself from previous literature addressing the connection between systematic risk and CSP by focusing on regional differences in an international sample, using the very transparent CSP measures of Asset4, identifying underlying impact drivers, and testing for robustness to alternative measures of systematic risk.

The use of investment decision techniques and tools in practice in a frontier market: Evidence from Ghana

We apply a survey approach to investigate investment decision techniques and tools in practice among listed firms in Ghana. We find that chief financial officers (CFOs) consider the payback period the most used capital budgeting tool, which is not in line with current literature trends. For the cost of equity, the results indicate that there is low or no effort by CFOs in estimating it when calculating the cost of capital. This implies CFOs may be using the cost of debt as the cost of capital. This article provides the improvement opportunities that may support firm value maximisation in a frontier market.

Firm performance and cost of equity capital: the moderating role of narrative risk disclosure quality in Egypt

This paper aims to examine the moderating effect of the narrative risk disclosure quality on the association between firm performance and the cost of equity capital in the Egyptian setting. Manual content analysis and factorial principal component techniques are used to quantify the quality dimensions of the narrative risk disclosures. The weighted average cost of equity is used to estimate the firms’ costs of equity. A cross-sectional analysis was conducted over three years (2018–2020) for a sample of 73 non-financial firms listed on the Egyptian Stock Exchange (EGX100). Multiple OLS regression models are employed to test the hypotheses. The results reveal a negative association between firm performance and the cost of equity and, while such association strengthened when adding the narrative risk disclosure quality as a moderator variable. This suggests that risk disclosure is important to stockholders’ investment decision-making in the Egyptian context. Based on the dearth of literature related to the economic reverberations of narrative risk disclosure quality in emerging economies, this study contributes to the risk reporting literature by providing evidence on the moderating effect of the narrative risk disclosure quality and its reverberations on the firm’s cost of equity capital in one of the emerging economies as Egypt. With regard to the findings of this study, we expect to contribute to the practice and theory by providing new and different insights about the moderating effect of narrative risk disclosure on the association between firm performance and cost of equity capital.

Corporate Social Responsibility, Investor Time Preferences, and Cost of Equity

Corporate Social Responsibility, Investor Time Preferences, and Cost of Equity

The Concept of Using the Excess Rate of Return in the Study of the Impact of EU ETS on the Value of Enterprises

The aim of the study is to assess the impact of the EU ETS on the profitability and the excess rate of return (ERR), which is the difference between profitability and the cost of capital. The study was conducted between 2008 and 2016 on a sample of 91 very large companies covered by the EU ETS. Models for panel data were used for the analysis. No statistically significant relationship between emission allowances and return on equity was found. However, a statistically significant relationship between emission allowances and ERR was detected. This could mean that companies were able to pass on the cost of emission allowances to their counterparties. However, greenhouse gas emissions entail greater exposure to the price risk of emission allowances, which the companies were unable to diversify, resulting in an increase in the cost of equity. Moreover, the study shows that the effect of emission allowances on the value of companies may not be symmetrical, as the variable under study was only statistically significant when it took on positive values (GHG emissions were higher than the allocation). As proven, an analysis of the excess returns can help to explain some of the inconsistencies and contribute to a better understanding of the impact of the EU ETS on the value of companies. The research carried out helps to answer the question of who bears the costs of reducing greenhouse gases and is it true that there are no costs for companies and therefore the introduction of the EU ETS has not affected their value. The conclusions of this study may be of interest to policymakers, investors but also to the public.

The Cost of Equity: Evidence from Investment Banking Valuations

The Cost of Equity: Evidence from Investment Banking Valuations

Faster than Flying: High-Speed Rail, Investors, and Firms

We study the effects of a direct high-speed rail (HSR) service between two cities on investors and firms in China. We find that, after an HSR introduction, investors make more cross-city searches and block purchases of firms in connected cities. An HSR introduction also leads to less co-movement among local stocks and more co-movement between stocks in connected cities. Firms located in more central cities in the HSR network enjoy higher firm valuation, lower cost of equity, and better liquidity, in part through the channel of increased investor recognition. The HSR effects on valuation, cost of equity, and liquidity are more pronounced among small firms and when the connected city-pair distance is below 1,500 km, for which HSR is faster than flying.

Methods for risk premium: Application for agriculture companies in Czech Republic

In business valuation, alternative cost of equity plays an important role considering the risk related to investment. Even a slight change in cost of equity can significantly affect the resulting business value. However, in the Czech Republic, risk premium has not been adequately addressed in terms of methodology. The objective of the paper is to explore the application of selected methods in calculating risk premium, and to select or modify existing methodology for the calculation of risk premium used in agricultural companies. For the purposes of determining the alternative cost of equity, three methods are selected: build up model, CAPM, and Fama and French Three Factor model; internal data of a family farm XY are used. Beta coefficient is calculated on the basis of the input data, and the results of the individual methods are compared. Based on the data of companies operating in the Czech market, the performed analysis suggests that the Build Up model is suitable for expressing alternative cost of equity. The agriculture sector is very specific, as agricultural companies are the first to be affected by the climate change. A follow-up study could be focused on the analysis and prediction of the impacts of climate change, with possible emphasis on the importance of weather derivatives for agriculture companies.

The Effect of Financial Distress and Corporate Governance on the Discretionary Allowance for Impairment Losses

Abstract: Purpose: This study provides a more accurate picture of how financial distress and corporate governance influence managerial discretion, where the target of this research is the banking industry which is the industry with the largest financial assets. Companies that have large financial assets also have large allowances for impairment losses, and this is the main factor driving accrual-based company profits. This research activity is expected to provide scientific and practical benefits as well as a new view on financial distress, corporate governance and managerial discretion. For the banking industry, it provides an understanding of whether the recognition of allowance for impairment losses can be affected by financial distress and/or corporate governance. Method: This research uses a multiple linear regression with quantitative data. The sample selection in this study was carried out using a purposive sampling method, which is a sampling method that applies certain criteria according to the research objectives. The population in this study are companies in the banking industry that are listed on the Indonesian Stock Exchange. In this study, five years of observation were carried out from 2017 to 2021. Result: Based on the results of this study, it can be concluded that financial distress, institutional ownership, proportion of independent commissioners, and proportion of audit committee have no effect on managerial discretion. It refutes the hypotheses regarding the influence of financial distress and corporate governance on managerial discretion over the recognition of allowance for impairment losses. However, the managerial ownership has a positive influence on managerial discretion, which raises a possibility that managers who own shares of a company have a desire to get more benefits from the cost of equity and/or capital gains. Keywords: 1. Financial Distress 2. Institutional Ownership 3. Managerial Ownership 4. Independent Commissioners 5. Audit Committee 6. Managerial Discretion 7. Allowance For Impairment Losses 8. banking

Firm Inflexibility and the Implied Cost of Equity

Firm Inflexibility and the Implied Cost of Equity

Short-run and Long-run Effects of ESG Policies on Value Creation and the Cost of Equity of Firms

Short-run and Long-run Effects of ESG Policies on Value Creation and the Cost of Equity of Firms

Competitive advantages of going public: Evidence from incumbent firms in the USA

Industry incumbent firms (existing public peer firms) experience significant negative stock returns around large initial public offerings (IPO) events in the same industry (Hsu, Reed, & Rocholl, 2010), implying a competitive advantage shift resulting from IPO events. We investigate whether such large IPO events generate real impact in the long run and increase the risk and thus cost of equity of incumbent firms. Using data from 1998–2019, we found that within three years after large IPO events, industry incumbents exhibit positive abnormal returns even after controlling for known asset pricing factors. In addition, their default probability also increases. Using intertemporal capital asset pricing model (ICAPM), we show that incumbent firms’ stock returns become more sensitive to economic conditions, in other words, riskier. Following Hou and Robinson (2006), we propose that the increased risk to incumbent firms comes from industry competition. We provide empirical evidence that this is the case. Specifically, firms in industries with low product differentiability, a large number of public firms, and smaller market size have larger increases in expected returns. As robustness tests, we document that industry incumbents exhibit declines in unexpected earnings, which contradicts the notion that the observed positive returns can be attributed to persistent positive cash flow for industry incumbent

Government Ownership and Bank Cost of Equity

Government Ownership and Bank Cost of Equity

Forecasting the cross-sectional stock returns: Evidence from the United Kingdom

The study provides the forecasts of expected returns based on cross-sectional estimates from the Fama-Macbeth regressions in the United Kingdom. We collected the data of listed firms on the London Stock Exchange on the DataStream from January 1980 to December 2020. We analyze the data sample by employing three cross-sectional models' ten-year rolling estimates of Fama-Macbeth slopes. The empirical findings demonstrate that an investor can derive a composite estimate of the expected return by integrating various company-specific variables in real-time. Model 1 indicates that the expected-return estimates have a predictive slope for future monthly returns of 95.07%, with a standard error of 0.1981. Moreover, model 2 and model 3 report the predictability of returns are 77.57% and 76.94%. In short, our empirical evidence suggests that investors and stakeholders may consider using model 1 to estimate the cost of equity due to its simplicity and effective prediction capability. Our findings are consistent with trade-off theory and prior literature.