Properties of Implied Cost of Capital Using Analysts’ Forecasts

Australian Journal of Management, Vol. 36, No. 2, 2011

26 Pages Posted: 5 May 2011 Last revised: 17 Aug 2012

See all articles by Wayne R. Guay

Wayne R. Guay

University of Pennsylvania - Accounting Department

S.P. Kothari

Massachusetts Institute of Technology (MIT) - Sloan School of Management

Susan Shu

Boston College - Carroll School of Management

Multiple version iconThere are 2 versions of this paper

Date Written: May 3, 2011

Abstract

We evaluate the influence of measurement error in analysts’ forecasts on the accuracy of implied cost of capital estimates from various implementations of the ‘implied cost of capital’ approach, and develop corrections for the measurement error. We document predictable error in the implied cost of capital estimates resulting from analysts’ forecasts that are sluggish with respect to information in past stock returns. We propose two methods to mitigate the influence of sluggish forecasts on the implied cost of capital estimates. These methods substantially improve the ability of the implied cost of capital estimates to explain cross-sectional variation in future stock returns, which is consistent with the corrections being effective in mitigating the error in the estimates due to analysts’ sluggishness.

Keywords: implied cost of capital, earnings forecasts, expected returns, analysts’ forecasts

JEL Classification: G12, M41, G29, G31, G32

Suggested Citation

Guay, Wayne R. and Kothari, S.P. and Shu, Susan, Properties of Implied Cost of Capital Using Analysts’ Forecasts (May 3, 2011). Australian Journal of Management, Vol. 36, No. 2, 2011, Available at SSRN: https://ssrn.com/abstract=1830627

Wayne R. Guay (Contact Author)

University of Pennsylvania - Accounting Department ( email )

3641 Locust Walk
1329 Steinberg-Dietrich Hall
Philadelphia, PA 19104-6365
United States
215-898-7775 (Phone)
215-573-2054 (Fax)

S.P. Kothari

Massachusetts Institute of Technology (MIT) - Sloan School of Management ( email )

E52-325
Cambridge, MA 02142
United States
617-253-0994 (Phone)
617-253-0603 (Fax)

Susan Shu

Boston College - Carroll School of Management ( email )

Boston College
140 Commonwealth Ave.
Chestnut Hill, MA 02167
United States
617-552-1759 (Phone)

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