Earnings Smoothness, Average Returns, and Implied Cost of Equity Capital

2010 ◽  
Vol 85 (1) ◽  
pp. 315-341 ◽  
Author(s):  
John McInnis
Keyword(s):  
Stock Returns ◽  
Lower Cost ◽  
Cost Of Capital ◽  
Empirical Work ◽  
Earnings Forecasts ◽  
Equity Capital ◽  
Cost Of Equity Capital ◽  
Cost Of Equity ◽  
Implied Cost Of Capital ◽  
Earnings Smoothness

ABSTRACT: Despite a belief among corporate executives that smooth earnings paths lead to a lower cost of equity capital, I find no relation between earnings smoothness and average stock returns over the last 30 years. In other words, owners of firms with volatile earnings are not compensated with higher returns, as one would expect if volatile earnings lead to greater risk exposure. Although prior empirical work links smoother earnings to a lower implied cost of capital, I offer evidence that this link is driven primarily by optimism in analysts' long-term earnings forecasts. This optimism yields target prices and implied cost of capital estimates that are systematically too high for firms with volatile earnings. Overall, the evidence is inconsistent with the notion that attempts to smooth earnings can lead to a lower cost of equity capital.

The Cost of Equity Capital in Stock Portfolios Listed on the Warsaw Stock Exchange Using the Classic CAPM

e-Finanse ◽  
2019 ◽  
Vol 15 (2) ◽  
pp. 48-62
Author(s):  
Stanisław Urbański
Keyword(s):  
Real Options ◽  
Stock Returns ◽  
Cost Of Capital ◽  
Stock Exchange ◽  
Bootstrap Method ◽  
Equity Capital ◽  
Cost Of Equity Capital ◽  
Cost Of Equity ◽  
Warsaw Stock Exchange ◽  
The Cost

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.

Does voluntary adoption of XBRL reduce cost of equity capital?

2014 ◽  
Vol 22 (2) ◽  
pp. 86-102 ◽  
Author(s):  
Lizhong Hao ◽  
Joseph H. Zhang ◽  
Jing (Bob) Fang
Keyword(s):  
Financial Reporting ◽  
Lower Cost ◽  
Cost Of Capital ◽  
Equity Capital ◽  
Economic Consequences ◽  
Fiscal Year ◽  
Cost Of Equity Capital ◽  
Cost Of Equity ◽  
Content Type ◽  
Voluntary Adoption

Purpose – The paper aims to examine whether or not firms voluntarily filing in XBRL (eXtensible Business Reporting Language) format enjoy a lower cost of capital. XBRL, or “interactive data” as the US Securities and Exchange Commission refers to it, is an information format that enables electronic exchange of standardized business and financial information. Design/methodology/approach – The authors investigate whether voluntary adoption of XBRL impacts cost of equity capital using a sample of US firms participated in the SEC Voluntary Filer Program, each matched with a pair of non-XBRL filers (matched by two-digit SIC code, same fiscal yearend, and close total assets in the same year). The authors measure firm-specific cost of equity capital at the fiscal year of last voluntary XBRL filing, using the PEG ratio model proposed by Easton, Gode and Mohanram, and Hou et al. Findings – The results show that cost of equity capital is significantly and negatively associated with XBRL adoption. The magnitude of the coefficient on XBRL suggests that firms voluntarily adopting XBRL are associated with an average reduction in cost of equity capital by 17-20 basis points (conditional on different cost of capital measures). Research limitations/implications – There is a research limitation due to the sample of voluntary XBRL adopters as of self-selection bias. The authors address this issue by using the Heckman two-stage regression procedure. Practical implications – The study provides evidence on the economic consequence of XBRL adoption in that it benefits shareholders by reducing the cost of equity capital. The evidence should provide regulators like the SEC more incentives to mandate the XBRL standard and motivate companies to adopt the standard as well. Originality/value – By showing that voluntary XBRL adopters are associated with lower cost of equity capital, the study provides timely and relevant empirical evidence to the economic consequences of voluntary adoption of XBRL. It also contributes to the limited empirical research on the economic consequences of new information technology and highlights the importance of institutional regulation in shaping the outcomes of new financial reporting format.

scholarly journals Impact of Corporate Political Connections on Cost of Equity: A Dynamic Panel Approach

2021 ◽  
Vol 13 (3) ◽  
pp. 45-65
Author(s):  
Aamir Amanat ◽  
Ahmed Imran Hunjra ◽  
Salman Ali Qureshi ◽  
Muhammad Hanif ◽  
Muhammad Razzaq Athar
Keyword(s):  
Lower Cost ◽  
Stock Exchange ◽  
Generalized Method Of Moments ◽  
Equity Capital ◽  
Political Connections ◽  
Cost Of Equity Capital ◽  
Cost Of Equity ◽  
Financing Cost ◽  
Corporate Political Strategies ◽  
The Impact

We analyze the impact of corporate political connections on the cost of equity of non-financial firms listed at the Pakistan Stock Exchange. We extract data from the DataStream and Election Commission of Pakistan for the years 2001 to 2018. The Generalized Method of Moments is used for data analysis. This research finds that firms use political connections to enjoy a lower cost of equity capital. Further, firms with strong ties to political power obtain more benefits on financing cost as compared to non-connected firms. Besides, we also find that firms affiliated with a large business group enjoy a lower cost of equity than non-affiliated connected firms. The findings may be helpful for regulators to formulate suitable policies concerning the use of corporate political strategies and to assist unconnected and non-affiliated firms to access finance easily.

scholarly journals A Better Way To Measure The Cost Of Equity Capital For Small Closely Held Firms

2012 ◽  
Vol 10 (2) ◽  
pp. 97
Author(s):  
Denis O. Boudreaux ◽  
Praveen Das ◽  
Nancy Rumore ◽  
SPUma Rao
Keyword(s):  
Cost Of Capital ◽  
Average Rate ◽  
Equity Capital ◽  
Cost Of Equity Capital ◽  
Cost Of Equity ◽  
Publicly Traded ◽  
Simple Method ◽  
Valuation Process ◽  
The Cost ◽  
Privately Owned

A companys cost of capital is the average rate it pays for the use of its capital funds. Estimating the cost of equity capital for a publicly traded firm is much simpler than estimating the same for a small privately held firm. For privately owned firms there is the lack of market based financial information. In business damage cases, valuation of the firm is often a prime interest. A necessary variable in the valuation process is the estimate of the firms cost of capital. Part of the cost of capital is the equity holders or owners required rate of return. The purpose of this paper is to explore the theoretical structure that underlies the valuation process for business damage cases that involve privately owned businesses. Specifically, cost of equity capital estimate methods which appear in the current literature are examined, and a theoretically correct and simple method to measure cost of equity capital for closely held companies is offered.

scholarly journals Equity-Based Compensation For Outside Directors And Cost Of Equity Capital

2013 ◽  
Vol 30 (1) ◽  
pp. 15 ◽  
Author(s):  
Induck Hwang ◽  
Hyungtae Kim ◽  
Sangshin Pae
Keyword(s):  
Lower Cost ◽  
Negative Relationship ◽  
Equity Capital ◽  
Cost Of Equity Capital ◽  
Cost Of Equity ◽  
Outside Directors ◽  
Total Compensation ◽  
The Cost ◽  
Implied Cost Of Equity

<p>This study provides evidence on the association between equity-based compensation for outside directors and the implied cost of equity capital. Based on the premise that equity-based compensation for outside directors better aligns the interests of the directors with those of shareholders, we investigate whether the more equity-based compensation is granted to outside directors, the lower cost of equity capital firms enjoy. We find a negative relationship between the proportion of equity-based compensation to total compensation for outside directors and the cost of equity capital. Our findings suggest that equity-based compensation for outside directors, by motivating the directors to play their monitoring role more faithfully, reduces agency risks resulting in the lower cost of equity capital.</p>

Business Strategy and the Cost of Equity Capital: An Evaluation of Pure versus Hybrid Business Strategies

2018 ◽  
Vol 31 (2) ◽  
pp. 111-141 ◽  
Author(s):  
Mehdi Khedmati ◽  
Edwin KiaYang Lim ◽  
Vic Naiker ◽  
Farshid Navissi
Keyword(s):  
Product Differentiation ◽  
Business Strategy ◽  
Lower Cost ◽  
Equity Capital ◽  
Business Strategies ◽  
Cost Of Equity Capital ◽  
Cost Of Equity ◽  
Cost Leadership ◽  
Pure Product ◽  
The Cost

ABSTRACT We examine the effect of pure (product differentiation or cost leadership) versus hybrid (a mix of product differentiation and cost leadership) business strategies on the cost of equity capital. Our results suggest that firms with a pure, relative to a hybrid, business strategy have a significantly lower cost of equity, and the cost of equity effect is equally driven by pure product differentiation and pure cost leadership strategies. We also find that firms following a pure business strategy are associated with lower systematic risk. Further, the lower cost of equity effect of a pure product differentiation strategy is more pronounced in high-technology industries and in regions with greater innovative capital. Our findings are robust to an array of robustness checks including change specification regressions and various methods for addressing endogeneity. Data Availability: All data used in this study are publicly available from the sources identified in the paper.

Does integration lead to lower costs of equity?

2016 ◽  
Vol 42 (1) ◽  
pp. 86-112
Author(s):  
Jessica Dye ◽  
Aaron Gilbert ◽  
Gail Pacheco
Keyword(s):  
Empirical Evidence ◽  
Market Integration ◽  
Lower Cost ◽  
World Market ◽  
Equity Market ◽  
Equity Capital ◽  
Cost Of Equity Capital ◽  
Cost Of Equity ◽  
Market Conditions ◽  
Firm Level

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.

Are Banks Special?

2018 ◽  
Vol 08 (04) ◽  
pp. 1840004 ◽  
Author(s):  
Michel Crouhy ◽  
Dan Galai
Keyword(s):  
Capital Structure ◽  
Cost Of Capital ◽  
Equity Capital ◽  
Cost Of Equity Capital ◽  
Cost Of Equity ◽  
Market Conditions ◽  
The Cost ◽  
The Capital Structure

This paper addresses the following question: Are banks special firms that can achieve their goals only with high leverage, above and beyond what is considered acceptable for industrial corporations? This question is related to the issue of the cost of capital and how it is affected by leverage. If we accept the Modigliani–Miller (M&M) theorem (1958), then the capital structure is irrelevant for both the cost of capital and the value of the bank. Specifically, the M&M hypothesis argues that higher levels of equity capital reduce bank leverage and risk, leading to an offsetting decline in banks’ cost of equity capital. Hence, we ask the question whether banks are special firms such that M&M theorem does not apply to banks. We show that M&M propositions cannot be applied for banks primarily because of explicit guarantees and subsidies that provide incentives for increasing leverage. Then, some of the risk faced by the bank is transferred at no cost to the providers of these guarantees and subsidies, giving banks the incentive to increase leverage as much as they can. We show that under perfect market conditions, when risk is fairly priced, this opportunity vanishes.

scholarly journals The Role of Firms’ Life Cycle Stages on Voluntary Disclosure and Cost of Equity Capital in Brazilian Public Companies

2020 ◽  
Vol 17 (6) ◽  
pp. 601-620
Author(s):  
Paulo Victor Novaes ◽  
Jose Elias Almeida
Keyword(s):  
Life Cycle ◽  
Voluntary Disclosure ◽  
Cost Of Capital ◽  
Equity Capital ◽  
Growth Stages ◽  
Cost Of Equity Capital ◽  
Cost Of Equity ◽  
Public Companies ◽  
Life Cycle Stages ◽  
The Cost

We examine the effects of firms’ life cycle stages on voluntary disclosure and the cost of equity capital. We also examine the relationship between the interaction of life cycle stages and voluntary disclosures measures on cost of equity capital. Our sample consists of non-financial Brazilian public companies, covered by analysts between 2008 and 2014, collected from I/B/E/S and Comdinheiro databases. We find that voluntary disclosure level is higher for firms in maturity and growth stages. We also find that firms in introduction and decline life cycle stages show higher implied cost of capital, however declining firms that increase voluntary disclosure reduce their cost of capital. Moreover, mature firms significantly reduce such inherent risk by reporting social and environmental voluntary information. Our results are useful for investors, practitioners, and regulators to the understanding of the incentives of voluntary disclosure practices.

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