Higher Cost Of Equity Capital Research Articles

CEO extraversion and the cost of equity capital

AbstractWe examine whether CEO extraversion, an important personality trait associated with leadership, is associated with firms' expected cost of equity capital. We measure CEO extraversion using CEOs' speech patterns during the unscripted portion of conference calls. After controlling for multiple CEO and firm‐specific variables, we find a strong positive incremental association between CEO extraversion and firms' expected cost of capital. Moreover, cost of equity increases when a more extraverted CEO replaces a less extraverted CEO. In addition, we find that firms with relatively extraverted CEOs take more risk and exhibit lower credit ratings, which is associated with higher cost of equity capital. These results are statistically and economically meaningful and do not appear to be driven by reverse causality, endogenous matching, look‐ahead bias, or bias in analysts' earnings forecast.

Is institutional common ownership commonly priced? Insights from the cost of equity capital

This study examines the effect of institutional common ownership on a firm's cost of equity capital. Recent literature on common ownership yields opposing predictions: increased strategic alliance in the product market could increase the non-diversifiable covariance risk of a firm's cash flows with other firms, leading to a higher cost of equity capital. However, reduced product market risk that is in part non-diversifiable could lead to a lower cost of equity capital. In both baseline and difference-in-differences settings, we document a negative and significant relation between common ownership and the cost of equity capital. We also provide direct evidence that common ownership reduces product market predation risk, distress risk, and overall risk while increasing stock liquidity. We do not find sufficient evidence that improved corporate governance drives the main findings. Overall, our findings indicate that institutional common ownership offers benefits to individual firms by reducing the cost of equity financing.

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This study analyzes effects of alternative minimum tax (AMT) on firm’s cost of equity capital. Investigating a sample of public firms for 2011-2020, we find that firms paying AMT have a higher cost of equity capital. We also find that the cost of equity capital is higher when the firms paying AMT are non-small and medium-sized enterprises (SMEs). This study contributes to expanding the literature by empirically analyzing how tax regulation affects the capital market. Firms’ behavior motivated by tax regulation could affect the cost of equity capital which is the basis of the firms’ real economic decisions. Thus, the results suggest that tax policymakers make tax regulation more sophisticated.

The impact of corporate long-term tax avoidance and tax uncertainty on cost of equity capital: evidence from Korea

This study aims to investigate the impact of Korean firms' long-run tax avoidance on the cost of equity capital. To the end, we examine whether long-term tax avoidance and tax uncertainty are associated with the cost of equity capital. According to the implicit tax theory, tax-favoured investments can decrease the firm's expected operating income. Besides, implicit taxes generated by tax credit can have distributional effects: the tax benefits shift to other stakeholders than the shareholders of the firms opting for the legitimate tax avoidance. We find results that, controlling for firm's various risk factors, Korean firms' long-run tax avoidance is positively associated with higher cost of equity capital. The results suggest that the unfavourable implicit tax effects of long-run tax avoidance dominate the favourable tax saving effects for the part of shareholders.

Tax Haven Incorporation and the Cost of Capital*

ABSTRACTIncorporating the firm's corporate parent in a tax haven is a major decision that receives significant attention from many stakeholders, yet certain implications of this corporate strategy remain unclear. While tax haven incorporation offers tax savings, it also imposes risks that are potentially costly and hence important to consider. We predict and find a higher cost of equity capital in firms with parent companies that are incorporated in tax havens but that are primarily based in nonhaven countries. We also predict and find that the observed cost of equity premium is more pronounced in firms with greater tax risk, firm‐level information risk, and country‐level legal risk. We also employ corporate inversions in a difference‐in‐differences test and again find a positive relation between tax haven parent incorporation and the cost of capital. Our findings imply that an increased cost of capital is a material cost of tax haven parent incorporation. We contribute to the literatures on valuation of tax haven use, tax and nontax costs of corporate tax strategies, corporate inversions, and the relation between taxes and the cost of capital. Our study provides evidence on the tax and nontax risks of a uniquely observable tax strategy (i.e., tax haven parent incorporation) that could factor into firms' decisions about whether to incorporate in a tax haven and policymakers' efforts to deter such activity.

Annual report readability and the cost of equity capital

Using a large panel of U.S. public firms, we examine the relation between annual report readability and cost of equity capital. We hypothesize that complex textual reporting deters investors' ability to process and interpret annual reports, leading to higher information risk, and thus higher cost of equity financing. Consistent with our prediction, we find that greater textual complexity is associated with higher cost of equity capital. Our results are robust to a battery of sensitivity checks, including use of multiple estimation methods, alternative proxies of annual report readability and cost of equity capital measures, and potential endogeneity concerns. In addition, we hypothesize and test whether the nature of the relation between readability and cost of capital depends on the tone of 10-K filings. Our results show that the effect of annual report complexity on cost of equity is greater when disclosure tone is more negative or more ambiguous. We also find that the effect of annual report readability on cost of equity capital depends on the degree of stock market competition, level of institutional investors' ownership, and analyst coverage.

Annual Report Readability and the Cost of Equity Capital

Using a large panel of U.S. public firms, we examine the relation between annual report readability and cost of equity capital. We hypothesize that complex textual reporting deters investors’ ability to process and interpret annual reports, leading to higher information risk, and thus higher cost of equity financing. Consistent with our prediction, we find that greater textual complexity is associated with higher cost of equity capital. Our results are robust to a battery of sensitivity checks, including use of multiple estimation methods, alternative proxies of annual report readability and cost of equity capital measures, and potential endogeneity concerns. In addition, we hypothesize and test whether the nature of the relation between readability and cost of capital depends on the tone of 10-K filings. Our results show that the effect of annual report complexity on cost of equity is greater when disclosure tone is more negative or more ambiguous. We also find that the effect of annual report readability on cost of equity capital depends on the degree of stock market competition, level of institutional investors’ ownership, and analyst coverage.

Climate risk: The price of drought

We document a significant positive relation between drought risk and the cost of equity capital. Our estimation shows that the cost of equity capital is 92 basis points higher for firms affected by severe drought conditions. We provide evidence that when firms are affected by droughts, firms with higher local institutional holdings exhibit a higher cost of equity capital. This result supports the well-known local bias of institutional investors, and suggests that diversification cannot fully eliminate the loss in wealth caused by droughts. Consistent with theoretical predictions, we find that drought duration and drought intensity further increase a firm's risk premium. However, for firms with diversified cash flows/investments, geographically dispersed business operations, and high cash holdings, the impact of drought on the expected return is significantly lessened. Overall, our findings show that investors require a higher rate of returns on firms affected by droughts and offer implications on how firms can mitigate the impact of droughts on their cost of capital.

Tax Haven Incorporation and the Cost of Capital

Incorporating the firm’s corporate parent in a tax haven is a major decision that receives significant attention from many stakeholders, yet certain implications of this corporate strategy remain unclear. While tax haven incorporation offers tax savings, it also imposes risks that are potentially costly and hence important to consider. We predict and find a higher cost of equity capital in firms with parent companies that are incorporated in tax havens but that are primarily based in nonhaven countries. We also predict and find that the observed cost of equity premium is more pronounced in firms with greater tax risk, firm-level information risk, and country-level legal risk. We also employ corporate inversions in a difference-in-differences test and again find a positive relation between tax haven parent incorporation and the cost of capital. Our findings imply that an increased cost of capital is a material cost of tax haven parent incorporation. We contribute to the literatures on valuation of tax haven use, tax and nontax costs of corporate tax strategies, corporate inversions, and the relation between taxes and the cost of capital. Our study provides evidence on the tax and nontax risks of a uniquely observable tax strategy (i.e., tax haven parent incorporation) that could factor into firms’ decisions about whether to incorporate in a tax haven and policymakers’ efforts to deter such activity.

Institutional Common Ownership and Cost of Capital

This study examines the effect of institutional common ownership on a firm’s cost of equity capital. Recent empirical findings on common ownership yield opposing predictions: increased strategic alliance in the product market could increase the covariance of a firm’s cash flows with the other firms, leading to a higher cost of equity capital. Reduced product market risk that is in part non-diversifiable could lead to a lower cost of equity capital. In both OLS and difference-in-differences settings, we document a negative and significant relation between common ownership and the cost of equity capital. We also provide direct evidence on common ownership reduces product market predation risk, distress risk, and overall risk while increases stock liquidity. Overall, our findings indicate that common ownership offers benefits to individual firms by reducing the cost of equity financing.

Carbon disclosure, emission intensity and cost of equity capital: multi‐country evidence

AbstractThis study examines the joint effect of carbon disclosure and greenhouse gas (GHG) emissions on firms’ implied cost of equity capital (COC). Based on 4655 firm‐year observations across 34 countries, we find firms’ GHG emission intensity to be positively associated with COC. However, we find also that the penalty linked with higher COC is moderated by extensive carbon disclosure. We provide evidence that the extent of carbon disclosure helps reduce the premium required by investors to compensate for poor carbon performance. Our study provides insights to policymakers, investors and managers on the combined effect of carbon disclosure, and emission intensity.

CEO Extraversion and the Cost of Equity Capital

We examine whether CEO extraversion, an important personality trait associated with leadership, affects firms’ expected cost of equity capital. We measure CEO extraversion using CEOs’ speech patterns during the unscripted portion of conference calls. After controlling for multiple CEO and firm specific variables, we find a strong positive incremental association between CEO extraversion and firms’ expected cost of capital. Moreover, the cost of equity increases when a more extraverted CEO replaces a less extraverted CEO. In addition, we find that firms with relatively extraverted CEOs take more risk and exhibit lower credit ratings, which is associated with a higher cost of equity capital. These results are statistically and economically meaningful and do not appear to be driven by reverse causality or endogenous matching.

Carbon Disclosure, Emission Intensity and Cost of Equity Capital: Multi-Country Evidence

This study examines the joint effect of carbon disclosure and greenhouse gas (GHG) emissions on firms’ implied cost of equity capital (COC). Based on 4655 firm‐year observations across 34 countries, we find firms’ GHG emission intensity to be positively associated with COC. However, we find also that the penalty linked with higher COC is moderated by extensive carbon disclosure. We provide evidence that the extent of carbon disclosure helps reduce the premium required by investors to compensate for poor carbon performance. Our study provides insights to policymakers, investors and managers on the combined effect of carbon disclosure, and emission intensity.

Network Connections in REIT Markets

Relationships play a central role across the spectrum of real estate transactions. To better understand the role of relationships in real estate markets, we examine how the connectedness of REIT directors is associated with deal making, growth, and profitability. We find strong evidence that REIT connections are positively associated with both deal making and accounting-based measures of profitability; however, those relationships do not translate into better market returns or higher valuations. One explanation of these somewhat contradictory results is that connections also increase firm risk. Preliminary support for this conjecture is found through our examination of each firm's implied cost of equity capital. Specifically, we find increasing connectedness is associated with a higher cost of equity capital. Thus, connections appear to offer both advantages and disadvantages to REIT managers and shareholders.

Ambiguous Customer Identity Disclosure and the Cost of Equity Capital

In deciding how much customer information to disclose, managers face a tradeoff between the benefits of reducing information asymmetry and the losses of revealing proprietary information. This paper investigates which factors affect the level of ambiguous customer identity disclosure and whether such ambiguous disclosure affects the cost of equity capital. The empirical evidence shows that the proprietary cost is a crucial factor in ambiguous customer identity disclosure. Firms with a higher level of ambiguous customer identity disclosure generate a higher cost of equity capital. Moreover, the higher cost of equity capital is concentrated among firms under imperfect market competition.

Does integration lead to lower costs of equity?

Recent evidence has suggested that the benefits of equity market integration may not be shared equally by all firms. Making use of a firm-level measure of integration we investigate whether one of the documented benefits of equity market integration, lower cost of equity capital (COEC), holds for all Australian firms. Empirical evidence suggests that the degree of integration is reflected in firm COEC, albeit not in the expected way. Our results indicate that increased integration at the firm level leaves firms exposed to higher COEC when world market conditions are volatile.

Management Earnings Forecast Policies and the Cost of Equity Capital: Do Motives Matter?

I investigate whether managerial motivations for issuing management forecasts impact the relation between forecast policies and the cost of equity capital. Extant research on the relation between voluntary disclosure and the cost of equity capital assumes that management discloses information to credibly adjust investor expectations and, thus, lower cost of capital. My study is motivated by the low likelihood that all management forecasts yield the credible information underlying the beneficial effect on cost of equity capital. Drawing from the literature on management forecast incentives, I classify management forecast motivations other than cost of capital reduction into three categories: (1) compliance with exchange rules, (2) opportunism to benefit managerial self-interests, and (3) opportunism to benefit aligned managerial/existing shareholder interests. I find that, of firms that forecast, those with policies containing higher percentages of forecasts motivated by rule compliance, managerial opportunism, and aligned managerial/existing shareholder opportunism have higher cost of equity capital. Thus, evidence suggests that underlying forecast motivations impact the management earnings forecast policy-cost of equity capital relation.

Network Connections in REIT Markets

Relationships play a central role across the spectrum of real estate transactions. Whether negotiating prices, securing funding, or acquiring permits, knowing the right people provides multiple channels to facilitate deal making. To better understand the role of relationships in real estate markets, we examine how the connectedness of REIT directors is associated with deal making, growth, and profitability. We find strong evidence that REIT connections are positively associated with both deal making and accounting based measures of profitability, however, those relations do not translate into better market returns or higher valuations. One explanation of these somewhat contradictory results is that connections also increase firm risk. Preliminary support for this conjecture is found through our examination of each firm’s implied cost of equity capital. Specifically, we find increasing connectedness is associated with a higher cost of equity capital. Thus, connections appear to offer both advantages and disadvantages to REIT managers and shareholders.

The equity premium puzzle: empirical evidence for the “Korea Discount”

This study examines the cost of equity capital (COC) and the factors that influence the COC of listed Korean companies, and compares the COC of Korean companies with that of companies from 31 selected countries. The major research question is whether companies that are listed in an emerging market have a disadvantage as they are underpriced through a higher COC (as compared with companies that are traded in developed markets). Consistent with the “Korea Discount,” we find that the COC is significantly higher for Korean companies than for companies in other countries after controlling for other relevant factors. However, the “Korea Discount” has significantly eased in recent years.

Corporate Governance Quality and Cost of Equity in Financial Companies

There are many studies demonstrating how good corporate governance positively affects the economic-financial performance of companies, but few which examine the relationship between corporate governance and cost of equity capital. These mainly focus on multiple industries, and suggest that there are positive shareholder value implications for firms with stronger corporate governance mechanisms. This paper investigates the relationship between the quality of governance and the cost of equity in financial companies. It finds that financial companies with the best governance (both "internal" and "external") are associated with a higher cost of equity capital.