The Small-Sized Premium: Is It Really Relevant? Evidence from the European Equity Market

The valuation of a company reflects the expected return or equivalently, the cost of capital that investors demand in exchange for the risk assumed. Despite the ex-ante nature of the problem, the majority of empirical analysis has focused on factors explaining expected returns from an ex-post perspective. In this paper, we take a different approach and try to identify which factors are ex-ante included in discount rates, with particular attention to the so-called size premium. Starting from observed market capitalisations and company fundamentals, we obtain the implied cost of capital from the reverse engineering of a carefully designed fundamental valuation model. Panel data regressions are used to investigate the existence of a relation between the implied cost of capital and the firm’s size, including other control variables representative of the most cited asset pricing “anomalies”. Our sample comprises European non-financial stocks listed on primary markets, with half-yearly observations starting from the aftermath of the 2008 global financial crisis. Contrary to common wisdom, we find that the firm’s size has no tangible impact to explain the implied cost of capital.

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Is the new issue puzzle real? Evidence from implied cost of capital

International Journal of Managerial Finance ◽

10.1108/ijmf-09-2020-0494 ◽

2021 ◽

Vol ahead-of-print (ahead-of-print) ◽

Author(s):

Snow Han

Keyword(s):

Initial Public Offering ◽

Risk Premium ◽

Cost Of Capital ◽

Expected Returns ◽

Limited Information ◽

Content Type ◽

Listed Firms ◽

Implied Cost Of Capital ◽

Ex Post ◽

Ex Ante

PurposeThis study aims to provide new explanation of the new issue puzzle.Design/methodology/approachThis study uses market implied cost of capital (ICC), rather than ex post realized returns, as proxy for ex ante expected returns, and sheds new light on the question why initial public offering (IPO) firms underperform the market within a 3–5 years period after the offerings.FindingsUsing ICC, the author finds that the market expects to earn higher risk premium for new listing firms than similar firms, which is contradictory to the documented new issue puzzle. The higher expected returns come from higher idiosyncratic volatility for newly listed firms, which are young and have more growth opportunities. The author also reports that investors are negatively surprised by lower-than-expected performances of newly listed firms.Originality/valueThe author’s results provide new empirical evidence that the new issue puzzle does not exist. Previous results observed IPO firms' under-performance is attributable to that ex post realized returns are a noisy proxy for ex ante expected returns, especially for newly listed firms with limited information.

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Speculative Stock Price and Inadequacy of the Implied Cost of Capital as a Proxy for Expected Return

SSRN Electronic Journal ◽

10.2139/ssrn.3556359 ◽

2020 ◽

Author(s):

Robert Fong

Keyword(s):

Stock Price ◽

Cost Of Capital ◽

Expected Return ◽

Implied Cost Of Capital

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EX POST VERSUS EX ANTE MEASURES OF THE USER COST OF CAPITAL

Review of Income and Wealth ◽

10.1111/j.1475-4991.2007.00232.x ◽

2007 ◽

Vol 53 (2) ◽

pp. 295-317 ◽

Cited By ~ 29

Author(s):

Nicholas Oulton

Keyword(s):

Cost Of Capital ◽

User Cost ◽

Ex Post ◽

Ex Ante

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If a Construct Affects Mispricing No Affirmative Inference Can Be Drawn About the Effect of the Construct on Expected Return from the Relation of the Construct with the Implied Cost of Capital: Evidence from Accrual Quality

SSRN Electronic Journal ◽

10.2139/ssrn.2708568 ◽

2015 ◽

Author(s):

Jing Fang

Keyword(s):

Cost Of Capital ◽

Expected Return ◽

Accrual Quality ◽

Implied Cost Of Capital

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Information and the Cost of Capital: An Ex Ante Perspective

The Accounting Review ◽

10.2308/accr.2010.85.3.817 ◽

2010 ◽

Vol 85 (3) ◽

pp. 817-848 ◽

Cited By ~ 76

Author(s):

Peter O. Christensen ◽

Leonidas E. de la Rosa ◽

Gerald A. Feltham

Keyword(s):

Rational Expectations ◽

Cost Of Capital ◽

Public Disclosure ◽

Full Time ◽

Recent Discussion ◽

Equilibrium Prices ◽

Ex Post ◽

Ex Ante ◽

The Cost ◽

The Impact

ABSTRACT: Recent articles have demonstrated that increased public disclosure can decrease firms’ cost of capital. The focus has been on the impact of information on the cost of capital subsequent to the release of the information (the ex post cost of capital). We show that the reduction in the ex post cost of capital is offset by an equal increase in the cost of capital for the period leading up to the release of the information (the preposterior cost of capital). Thus, within the class of models framing the recent discussion, there is no impact on the ex ante cost of capital covering the full time span of the firm. The extent to which information is made publicly or privately available affects the timing of the resolution of uncertainty and when the information is reflected in equilibrium prices, but there is no impact on initial equilibrium prices. Within a noisy rational expectations equilibrium, rational investors may actually benefit from a higher ex post cost of capital.

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Noise, Information, and the Favorite-Longshot Bias in Parimutuel Predictions

American Economic Journal Microeconomics ◽

10.1257/mic.2.1.58 ◽

2010 ◽

Vol 2 (1) ◽

pp. 58-85 ◽

Cited By ~ 26

Author(s):

Marco Ottaviani ◽

Peter Norman Sørensen

Keyword(s):

Private Information ◽

Expected Return ◽

Ex Post ◽

Ex Ante

According to the favorite-longshot bias, the expected return on an outcome tends to increase in the fraction of bets laid on that outcome. We derive testable implications for the direction and extent of the bias depending on the ratio of private information to noise present in the market. We link this ratio to observables such as the number of bettors, the number of outcomes, the amount of private information, the level of participation generated by recreational interest in the event, the divisibility of bets, the presence of ex post noise, as well as ex ante asymmetries across outcomes. (JEL D81, D83)

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Performance vs prospectus = transparency in German closed-ended real estate funds?

Journal of Property Investment and Finance ◽

10.1108/jpif-11-2016-0084 ◽

2018 ◽

Vol 36 (2) ◽

pp. 158-170 ◽

Cited By ~ 1

Author(s):

Michael Nadler

Keyword(s):

Real Estate ◽

Private Equity ◽

Global Financial Crisis ◽

Variance Analysis ◽

German Market ◽

Content Type ◽

Fund Managers ◽

Ex Post ◽

Ex Ante ◽

The Impact

Purpose The purpose of this paper is to close the transparency gap by comparing ex ante and ex post performance disclosure, thus providing important conclusions regarding the transparency of this important German market segment. Design/methodology/approach Closed-ended real estate funds (CEREFs) are one of the biggest segments of unlisted private equity funds in Germany. CEREFs have a central “profitability promise” that is based on ex ante forecasts given in the prospectus. Typically, equity is tied to these investments for up to 20-30 years, leaving investors highly insecure whether their expectations will be fulfilled and fund managers actually achieve prospected performances ex post. Findings The performance variance analysis of all German CEREFs outstanding during the global financial crisis reveals that prospect-performance disclosures as well as prospect-performance variances cause substantial problems in Germany due to overestimation biases of many fund managers. Research limitations/implications As typical for the recent scholarly debate, also the past disclosure practice in Germany prohibits a long-term performance analysis, unless researchers apply instruments of modern investment analysis like comprehensive financial plans (“Visualisation of Financial Implications)”. Practical implications The transparency developments in CEREF-reporting of the last decade deliver precise recommendations regarding the internal and external performance variance analysis, risk-profiles and stress tests for the future fund management. Social implications The introduced methodology would increase transparency in the segment of CEREF and, thus, improve investor protection. Since private households in Germany mainly acquire these funds, this is a contribution to sustainability in private asset management. Originality/value The paper develops a new methodological framework for performance measurement of unlisted funds. It then assesses for the first time the impact of transparency and trust on fund performances by applying a performance variance analysis.

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