The Fama-French model for estimating the cost of equity capital: The impact of real options of investment projects

2021 ◽  
pp. 100874
Author(s):  
Stanisław Urbanski ◽  
Dariusz Zarzecki
2021 ◽  
Vol ahead-of-print (ahead-of-print) ◽  
Author(s):  
Ahmed Hassan Ahmed ◽  
Yasean Tahat ◽  
Yasser Eliwa ◽  
Bruce Burton

Purpose Earnings quality is of great concern to corporate stakeholders, including capital providers in international markets with widely varying regulatory pedigrees and ownership patterns. This paper aims to examine the association between the cost of equity capital and earnings quality, contextualised via tests that incorporate the potential for moderating effects around institutional settings. The analysis focuses on and compares evidence relating to (common law) UK/US firms and (civil law) German firms over the period 2005–2018 and seeks to identify whether, given institutional dissimilarities, significant differences exist between the two settings. Design/methodology/approach First, the authors undertake a review of the extant literature on the link between earnings quality and the cost of capital. Second, using a sample of 948 listed companies from the USA, the UK and Germany over the period 2005 to 2018, the authors estimate four implied cost of equity capital proxies. The relationship between companies’ cost of equity capital and their earnings quality is then investigated. Findings Consistent with theoretical reasoning and prior empirical analyses, the authors find a statistically negative association between earnings quality, evidenced by information relating to accruals and the cost of equity capital. However, when they extend the analysis by investigating the combined effect of institutional ownership and earnings quality on financing cost, the impact – while negative overall – is found to vary across legal backdrops. Research limitations/implications This paper uses institutional ownership as a mediating variable in the association between earnings quality and the cost of equity capital, but this is not intended to suggest that other measures may be of relevance here and additional research might usefully expand the analysis to incorporate other forms of ownership including state and foreign bases. Second, and suggestive of another avenue for developing the work presented in the study, the authors have used accrual measures of earnings quality. Practical implications The results are shown to provide potentially important insights for policymakers, creditors and investors about the consequences of earnings quality variability. The results should be of interest to firms seeking to reduce their financing costs and retain financial viability in the wake of the impact of the Covid-19 pandemic. Originality/value The reported findings extends the single-country results of Eliwa et al. (2016) for the UK firms and Francis et al. (2005) for the USA, whereby both reported that the cost of equity capital is negatively associated with earnings quality attributes. Second, in a further increment to the extant literature (particularly Francis et al., 2005 and Eliwa et al., 2016), the authors find the effect of institutional ownership to be influential, with a significantly positive impact on the association between earnings quality and the cost of equity capital, suggesting in turn that institutional ownership can improve firms’ ability to secure cheaper funding by virtue of robust monitoring. While this result holds for the whole sample (the USA, the UK and Germany), country-level analysis shows that the result holds only for the common law countries (the UK and the USA) and not for Germany, consistent with the notion that extant legal systems are a determining factor in this context. This novel finding points to a role for institutional investors in watching and improving the quality of financial reports that are valued by the market in its price formation activity.


2020 ◽  
Vol 21 (6) ◽  
pp. 985-1007 ◽  
Author(s):  
Antonio Salvi ◽  
Filippo Vitolla ◽  
Nicola Raimo ◽  
Michele Rubino ◽  
Felice Petruzzella

PurposeThe purpose of this study is to examine the impact of intellectual capital disclosure on the cost of equity capital in the context of integrated reporting, which represents the ultimate frontier in the field of corporate disclosure.Design/methodology/approachThe authors employ content analysis to measure intellectual capital disclosure levels along with a panel analysis on a sample of 164 integrated reports.FindingsEmpirical outcomes indicate that intellectual capital disclosure levels have a significantly negative association with the cost of equity capital.Originality/valueThis study's major contribution lies in its originality in terms of empirical examination of the relationship between intellectual capital disclosure in integrated reports and the cost of equity capital.


2019 ◽  
Vol 29 (2) ◽  
pp. 519-529 ◽  
Author(s):  
Filippo Vitolla ◽  
Antonio Salvi ◽  
Nicola Raimo ◽  
Felice Petruzzella ◽  
Michele Rubino

2020 ◽  
pp. 0148558X2097194
Author(s):  
Jiajia Fu ◽  
Yuan Ji ◽  
Jiao Jing

Rank and file employees execute firms’ daily operating activities, but prior research rarely examines their importance due to a lack of employee information. In this article, we use a novel data set—company reviews by rank and file employees—to provide evidence on the impact of employee satisfaction on a firm’s cost of equity capital. We find that firms with higher employee satisfaction have a lower cost of equity. Our results are robust to a variety of endogeneity tests and model specifications. We also find that the effect of employee satisfaction is more pronounced for firms with higher risk, greater financial constraints, and higher labor intensity or product market competition where labor is more critical to firm success. Further analysis shows that the negative association between employee satisfaction and the cost of equity is primarily grounded in reviews from current rather than former employees. Finally, we document that firms with high employee satisfaction experience lower systematic and idiosyncratic risk. Overall, our article presents novel evidence on the capital market benefits of higher employee satisfaction, particularly with regard to financing cost reduction.


e-Finanse ◽  
2019 ◽  
Vol 15 (2) ◽  
pp. 48-62
Author(s):  
Stanisław Urbański

AbstractThis work is an attempt to estimate the cost of equity capital characteristic among portfolios of companies listed on the Warsaw Stock Exchange in the years 1995-2017. To this end, the classic CAPM is used to estimate the cost of risk. Model tests are based on 252 monthly returns. In order to assess the errors of cost of capital estimation, the bootstrap method is used. The estimated cost of capital refers to the project portfolio with real options on these projects. Stock returns are generated not only by the companies implementing projects but also through real options modifying these projects. The estimated cost of capital can be a valuable indicator for portfolio managers. Also, it can be an approximate indicator for making decisions on the implementation of new investment projects. The estimated cost of capital assumes the highest values for value portfolios. The estimated cost of capital assumes the small values for growth portfolios.


2018 ◽  
Vol 13 (1) ◽  
Author(s):  
Fiki Kartika

This research aims to determine the impact of Good Corporate Governance (GCG) on the cost of equity for manufacturing companies in Indonesia. The sampling technique uses purposive sampling, namely companies listed on the Indonesia Stock Exchange. The analysis was carried out in the Manufacturing industry sector in 2013 - 2015. The GCG index was measured using five dimensions adopted from Black et al. (2003) and Cost of Equity is measured by the ex ante cost of equity capital using the Price Earning Growth (PEG) proxy. The reason for using ex ante cost of equity capital is ex-ante is more describing the role of investors in seeing the risk of a company. The results of this study indicate that GCG negatively affects on the cost of equity. GCG limits managerial opportunism and reduces agency conflicts between owners and agents. Therefore, shareholders are willing to accept a lower risk premium, effectively reducing equity costs.


Author(s):  
Saerona Kim ◽  
Haeyoung Ryu

Purpose The purpose of this paper is to examine the effects of adoption of the mandatory International Financial Reporting Standards (IFRS) on the cost of equity capital in a unique Korean setting. In Korea, individual financial statements were taken as primary financial statements. Before the adoption of IFRS, consolidated financial statements were taken as supplementary financial statements. Design/methodology/approach The authors measure the cost of equity using the average estimates from the implied cost of capital models proposed by Claus and Thomas (2001), Gebhardt et al. (2001), Easton (2004) and Ohlson and Juettner-Nauroth (2005), using it as the primary dependent variable. Mandatory IFRS adoption, the independent variable in this study, is assigned a value of 1 for the post-adoption period and 0 otherwise. Findings Using a sample of listed Korean companies during the period from 2000 to 2013, the authors find evidence of a significant reduction in the cost of equity capital in Korean listed companies after mandatory adoption of the IFRS in 2011, after controlling for a set of market variables. Originality/value This study is one of a growing body of literature on the relations between mandatory IFRS adoption and the cost of equity capital (Easley and O’Hara 2004; Covrig et al. 2007; Lambert et al. 2007; Daske et al. 2008). According to the results of this study, increased financial disclosure and enhanced information comparability, along with changes in legal and institutional enforcement, seem to have had a joint effect on the cost of equity capital, leading to a large decrease in expected equity returns.


2010 ◽  
Vol 46 (1) ◽  
pp. 171-207 ◽  
Author(s):  
Kevin C. W. Chen ◽  
Zhihong Chen ◽  
K. C. John Wei

AbstractIn this paper, we examine the effect of shareholder rights on reducing the cost of equity and the impact of agency problems from free cash flow (FCF) on this effect. We find that firms with strong shareholder rights have a significantly lower implied cost of equity after controlling for risk factors, price momentum, analysts’ forecast biases, and industry and year effects than do firms with weak shareholder rights. Further analysis shows that the effect of shareholder rights on reducing the cost of equity is significantly stronger for firms with more severe agency problems from FCFs.


2021 ◽  
Vol 2021 ◽  
pp. 1-17
Author(s):  
Fu Cheng ◽  
Shanshan Ji

Due to the immaturity of bond market and the defects of internal governance structure, Chinese-listed companies have a strong preference for equity financing. How to reduce the cost of equity capital is particularly important for Chinese-listed companies. As an equity incentive system, employee stock ownership plan (ESOP) can reduce the agency conflicts among shareholders, executives, and employees to some extent. These reduced conflicts will, in an efficient capital market, be reflected in a lower cost of equity capital. This paper investigates whether the implementation of ESOP in a new era in China affects the cost of equity capital and further explores whether the impact of ESOP on the cost of equity capital is affected by the ownership nature, the firm size, and the contract design of ESOP. The results show that the implementation of ESOP reduces the cost of equity capital of enterprises. Compared with state-owned enterprises and large enterprises, the implementation of ESOP is more likely to reduce the cost of equity capital in non-state-owned enterprises and small enterprises. Furthermore, the reduction effect of ESOP on the cost of equity capital is influenced by the contract design of ESOP. This study not only enriches the literature on the relationship between employee stock ownership and the cost of equity capital but also provides a new idea for listed companies to reduce the cost of equity financing.


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