Property Crime, Earnings Variability, and the Cost of Capital
University of Arizona
Dan S. Dhaliwal
University of Arizona - Department of Accounting
Douglas J. Fairhurst
University of Arizona - Eller College of Management
Matthew A. Serfling
University of Arizona - Department of Finance
September 17, 2014
We study how a large and overlooked source of business risk that costs firms and investors billions of dollars annually — the risk of property theft — impacts a firm’s cost of equity capital. We hypothesize that a firm with a greater exposure to the risk of property theft has higher cash flow risk and lower expected cash flows, which results in a higher cost of equity. To test this hypothesis, we exploit variation in state-level property crime rates as a source of changes in a firm’s exposure to the risk of property theft. Consistent with our hypothesis, we find that a firm located in an area with a higher property crime rate has a higher cost of equity, especially when individuals have greater incentives and opportunities to steal from the firm. Additional analyses help rule out the alternative explanation that omitted variables related to overall criminal activity, local economic conditions, and characteristics of local labor markets drive our findings. Lastly, we provide evidence that a firm located in a more crime ridden area also has a higher cost of bank debt. Overall, our paper shows that a firm’s exposure to the risk of property theft can have an economically important impact on its financing costs.
Number of Pages in PDF File: 58
Keywords: Cost of equity, Theft, Crime, Business risk
JEL Classification: G12, M41working papers series
Date posted: December 22, 2013 ; Last revised: September 19, 2014
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