International financial markets appear to be becoming a single huge, integrated, global capital market—a development that is contributing to higher stock prices in developed as well as developing economies. For companies large and visible enough to attract global investors, having a global shareholder base means having a lower cost of capital, and hence a greater equity value, for two main reasons:First, because the risks of equity are shared among more investors with different portfolio exposures and hence a different “appetite” for bearing certain risks, equity market risk premiums should fall for all companies in countries with access to global markets. Although the largest reductions in cost of capital resulting from globalization will be experienced by companies in liberalizing economies that are gaining access to the global markets for the first time, risk premiums can also be expected to fall for companies in long‐integrated markets as well.Second, when companies in countries with less‐developed capital markets raise capital in the public markets of countries (like the U.S.) with highly developed markets, they get more than lower‐cost capital; they also import at least aspects of the corporate governance systems that prevail in those markets. For companies accustomed to less‐developed markets, raising capital overseas is likely to mean that more sophisticated investors, armed with more advanced technologies, will participate in monitoring their performance and management. And in a virtuous cycle, more effective monitoring is expected to increase investor confidence in the future performance of those companies and so improve the terms on which they raise capital.Besides reducing market risk premiums and improving corporate governance, globalization also affects the systematic risk, or “beta,” of individual companies. In global markets, the beta of a firm's equity depends on how the stock contributes to the volatility not of the home market portfolio, but of the world market portfolio. For companies with access to global capital markets whose profitability is tied more closely to the local than to the global economy, use of the traditional Capital Asset Pricing Model (CAPM) will overstate the cost of capital because risks that are not diversifiable within a national economy can be diversified by holding a global portfolio. Thus, to reflect the new reality of a globally determined cost of capital, all companies with access to global markets should consider using a global CAPM that views a company as part of the global portfolio of stocks.
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Mar 20, 2024
Emmanuel Alanis + 3
Open Access