Implied Cost of Equity Capital Estimates as Predictors of Accounting Returns and Stock Returns

Journal of Financial Reporting, Forthcoming

50 Pages Posted: 22 Dec 2013 Last revised: 1 Aug 2017

See all articles by Stephannie Larocque

Stephannie Larocque

University of Notre Dame - Mendoza College of Business

Matthew R. Lyle

Goizueta Business School

Date Written: July 6, 2017

Abstract

Using a popular return decomposition, we show that expected returns should on average be positively associated with future return on equity (ROE), controlling for the book-to-market ratio (BM). However, we find that none of the commonly-used implied cost of equity capital estimates (ICCs), which proxy for expected returns, are positively associated with future ROE. This lack of association with future accounting returns appears to affect the ability of ICCs to forecast future stock returns: ICCs do not provide information about future stock returns incremental to that contained in a linear combination of current ROE and BM. Our findings suggest that tractable accounting-based models that linearly combine BM and ROE, or other accounting-based variables, offer improvements on extant ICCs as expected returns proxies.

Keywords: cost of capital; expected returns; ROE

JEL Classification: M41, G3

Suggested Citation

Larocque, Stephannie A. and Lyle, Matthew R., Implied Cost of Equity Capital Estimates as Predictors of Accounting Returns and Stock Returns (July 6, 2017). Journal of Financial Reporting, Forthcoming, Available at SSRN: https://ssrn.com/abstract=2370686 or http://dx.doi.org/10.2139/ssrn.2370686

Stephannie A. Larocque (Contact Author)

University of Notre Dame - Mendoza College of Business ( email )

Mendoza College of Business
Notre Dame, IN 46556-5646
United States

Matthew R. Lyle

Goizueta Business School ( email )

1300 Clifton Road
Atlanta, GA 30322-2722
United States

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